By Rae Oakley, Flyhomes Mortgage
Financially savvy people know how to use the money in their homes to reach big goals … and in a minute, you will, too! Specifically, let’s explore two products that you should know about if you have sizeable equity in your home: home equity loans and home equity lines of credit (HELOCs).
What’s the difference?
Their names may sound virtually the same, but these two financial programs are a little different from one another.
Both a home equity loan and a home equity line of credit (HELOC, pronounced HEE – lok) allow you to take a certain amount of equity out of your home and both require monthly payments to pay back the amount that you borrow.
The main difference between the two is that a home equity loan provides you with the cash in one lump sum, whereas a HELOC acts as a revolving line of credit that you can pull from.
Generally, a home equity loan is a good choice if you need a specific amount for a project, like a renovation. A HELOC is a good choice if you want flexibility or aren’t sure how much cash you’ll need.
How they work
Taking out a home equity loan is like taking out an additional mortgage. Depending on the amount of equity you have in your home (the value of your home less the balance due on your mortgage), you can borrow cash from that amount and then pay it back (with interest) in monthly installments over time similarly to how you pay your first mortgage.
With a HELOC, your maximum credit limit is usually based on 75-85% of your home’s value. In order to find out your home’s value, you can estimate through comparable sales in your neighborhood, or check out online real estate estimators, but you will need an official valuation report completed by a licensed real estate appraiser to know how much your home is worth in the eyes of a lender.
HELOCs usually come with “draw periods” that are around 5-10 years in length, where your required payments are interest-only, meaning you’re not required to put the money you take out right back in. After this initial period, you pay back the balance borrowed with interest for the remaining 10-20 year period of the loan.
Also important to note: most home equity loans have fixed rate interest, whereas HELOCs are typically adjustable rate loans. Since adjustable rate loans adjust off of an index, like the one-year LIBOR, it is possible that the rate on your HELOC will increase (within the limit of its cap). This can make budgeting difficult and increases the amount of financial risk you take on.
Both of these programs allow you to tap into your equity without making any changes to your primary mortgage. This is great if you have a good rate on that mortgage, as it won’t be affected.
If you’re in the market for a new home and have less than 20% to put down, you can use a home equity loan to avoid paying mortgage insurance or to help you qualify for a jumbo loan.
Here’s how: apply for a first mortgage that is 80% of your home’s value and simultaneously apply for a home equity loan of 10%, allowing you to add in as little as 10% out of your current funds to get to 20% total. This is known as an 80-10-10 loan or a piggyback loan.
Some lenders that provide HELOCs will waive or share your closing costs for the loan, but be careful: there might be a strict pay-back period, prepayment fees, or other fees included in your final payment. Make sure you understand the details!
Are they right for you?
Home equity loans and HELOCs work best for you if:
– You want to tap into your home’s value without impacting your primary mortgage
– You can’t qualify for your jumbo loan without a second mortgage
– The mortgage insurance on your new purchase is more expensive than the payments on a home equity loan
– You want to access more of your home’s value than you could through a cash-out refinance
– You’re good at spending within your means (so you don’t get tempted to take out more than you need to just because you can)
If you’re curious about the amount that you’d qualify for, use one of the numerous HELOC calculators out there, like this one, that can help you estimate. From there, we recommend reaching out to your mortgage professional to figure out the best path forward for your particular situation.
Thinking about a home equity loan or HELOC?