You have options for borrowing against your home, but here's why a home equity loan may be the better choice.
Home values have risen exponentially over the past several months, as low mortgage rates and limited housing inventory on the market have fueled a surge in buyer demand. That's good news not just for homeowners who are looking to sell their homes, but also for those who are thinking of borrowing against their homes.
As a property owner, you can borrow against your home once you have enough equity in it. Equity is the portion of your home you own outright. If your home's market value (meaning, the amount it could sell for) is $300,000 and you owe $220,000 on your mortgage, it means you have $80,000 worth of equity.
Now when it comes to borrowing against your home, you have two choices:
- A home equity loan: A straight-up loan you take out and repay over time
- A home equity line of credit, or HELOC: A line of credit you draw from as needed over a certain period of time and only repay the amount you actually borrow
A lot of people like HELOCs because they're flexible -- you don't need to draw down your entire HELOC at once, and you generally get up to 10 years to borrow from it. But here are a couple of reasons why a home equity loan may be a better choice for you.
1. You won't be tempted to overborrow
When you take out a home equity loan, you commit to borrowing -- and repaying -- a specific amount from the start. With a HELOC, it's common to be granted the option to borrow more than what you need, since you don't have to draw all of your HELOC funds at once. But that flexibility could lead you to borrow more and end up with a burdensome loan to pay off.
Say you're looking to renovate your home and estimate it'll cost $20,000. With a home equity loan, you'd likely borrow just $20,000, knowing you'll definitely have to pay all of it back. With a HELOC, you might ask for a $30,000 line of credit just in case, knowing you can simply take the $20,000 you know you need but have a cushion left over.
Well, a year or two after your $20,000 renovation, you may want to go on vacation but run into the issue of money being tight. But wait -- you have $10,000 remaining in your HELOC, so you can get the money that way. That's a convenient option, of course, but a dangerous one, because generally speaking, you shouldn't borrow money to take vacations. Plus, if you access that extra $10,000, that's money you'll end up having to repay -- with interest.
2. You'll pay a fixed interest rate on your loan
When you take out a home equity loan, you'll get to pay it back at a fixed interest rate, so your payments will be nice and predictable. HELOC interest rates, on the other hand, can fluctuate over the life of your repayment period. That means your payments have the potential to go up over time. That could, in turn, mess up your household budget.
Of course, this isn't to say that HELOCs are a downright bad idea. In some cases, they're a good option. Rather, the point is that home equity loans can, in more than one regard, be a safer borrowing option to consider. Remember, if you fall behind on either home equity loan or HELOC payments, you could risk losing your home. And if a home equity loan helps keep your borrowing in check and guarantees predictable monthly payments, it could be a better choice for you.
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