You need to borrow money
to pay for your children's college education. Alternatively, maybe you want to
pay down your high-interest credit card debt or add a master bedroom addition
to the top floor of your home.
One way to do so is to
tap into the equity you've built up in your home.
Building up equity is
one of the most important benefits of owning a home. As you pay off your
mortgage, you gradually build equity. Simply put, equity is the amount of your
home that you actually own. For example, if you have a house worth $200,000 and
you owe $150,000 on your mortgage, you have equity of $50,000.
You can access that
equity in one of two ways, through a home equity loan or a home equity line of
credit.
Home
equity loan
A home equity loan is a
second mortgage. When you apply for a home equity loan, you'll receive a single
lump sum. You then pay that sum back over a set period of years. The size of
your home equity loan will be limited, of course, by the amount of equity you
have in your home.
The interest rate
attached to a home equity loan remains constant throughout the life of the
loan.
Home
equity line of credit
Consumers often confuse
home equity lines of credit -- better known as HELOCs -- with home equity loans.
However, a HELOC works more like a credit card than a mortgage loan.
With a HELOC, you'll
receive a set credit limit. You only pay back the amount of money that you
borrow, plus interest. For instance, if you have a HELOC with a credit limit of
$50,000 and you borrow $10,000 from it, you'll only have to pay back that
$10,000. You'll still have $40,000 worth of credit available to you after
you've borrowed the $10,000.
The interest rate on a
HELOC is usually tied to the prime rate. Often, the rate will be 1 percent over
prime.
Which
is better?
So, which product is
better? Not surprisingly, that depends on the individual borrower and the
individual situation.
Many economists say that
a home equity loan is better suited to borrowers who need funds for a specific
purchase, such as college tuition or a major kitchen remodel. Since a home
equity loan features a fixed interest rate, such a product might be better for
those borrowers uncomfortable with uncertainty.
A home equity line of
credit, though, provides more flexibility. Homeowners do not have to tap into
their credit unless they need it. Because of this, many homeowners use a HELOC
as an emergency fund, quick cash in the case of an emergency. A HELOC might be
the right choice, too, for borrowers taking on a multi-year renovation project.
These borrowers can then tap their HELOC whenever they need to write a check to
move the project toward completion.
The key is to do your
research before choosing either a HELOC or home
equity loan. Only by studying your
spending habits and needs will you be able to make the right equity decision.
