Knowing if a home equity loan or line of credit is right for you isn’t always straightforward. It’s normal to be asking yourself if you need it and which option to take, especially since these products aren’t the same as a mortgage loan. So, if you’re wondering what product is best for your financial future, you’re not alone.
In 2022, The LendingTree Senior Economic Analyst Jacob Channel reported that “an average of 23.96% of homeowners have considered improving their home’s equity to help consolidate some form of debt.” They also found that “using a home’s equity for non-home improvement investment purposes was the primary goal for an average of 9.16% of homeowners.”
Because there are many reasons why someone would consider tapping into their home’s equity, we wanted to create a helpful guide that can lead you to the correct solutions.
In this article, we’ll walk you through the differences between a home equity loan and home equity line of credit. We’ll also take a deep dive into the pros and cons of each option and how you can determine your best option. This way you feel more confident in your decision and empowered to take the next steps.
Let’s get started!
What is a Home Equity Loan?
According to Bankrate, “A Home Equity Loan is a loan that lets you borrow against the value of your home, with funds delivered as a lump sum.” In other words, a home equity loan helps you get the cash you need fast by allowing you to borrow against the equity in your home.
Typically, lenders will let you borrow up to 80 to 85% of your home’s value, minus what you owe on your mortgage. This a fast and easy way for you to access a large sum of money fast.
Since we go above for our credit union members, First New York Federal Credit Union allows our members to borrow up to 90% of the value of their home, up to $647,200. That’s 5-10% more than the industry average. Why? Because we want to provide great alternatives to larger financial institutions with high-interest, non-tax deductible loans.
Top 13 Common Uses of a Home Equity Loan
Some of the most common uses of a home equity loan or line of credit revolve around paying or funding large expenses like home improvements. Whatever your needs, this can be a good option to make the most of your home’s equity. Here, are the most common uses:
- Pay for home improvements
- Pay for a car
- Fund a vacation
- Cover unexpected expenses
- Stay ahead of educational costs
- Consolidate credit card or other high-interest debt with a lower interest rate
- Borrow a large sum of money
- Acquire a lump sum of money
- Cover medical expenses
- Use as a down payment for a second home
- Invest in real estate
- Use as a down payment for a rental investment property
- Get a tax deduction*
As you can see, there are many reasons why people are looking to borrow against the value of their homes. While it may seem counterintuitive, a home equity loan can be a smart way to help save money over time, especially if you’re consolidating your debt.
Now, that we’ve covered what a home equity loan is, let’s move into the pros and cons of this option.
What are the Pros and Cons of a Home Equity Loan?
Going over the pros and cons of something is one way to determine if something is right for you. Since you now know that home equity loans are a large lump sum of cash that you repay over a term, here are some specific pros and cons to consider.
Remember: These are broad pros and cons to each option, and they may vary depending on the bank or financial institution that you’re planning on applying to.
The Pros of a Home Equity Loan
- Lower, fixed interest rate
- Lower monthly payments
- You can use the money for any purpose
- Your interest payments may be tax-deductible*
The Cons of a Home Equity Loan
- You can’t get a home equity loan with too much debt or poor credit score
- You have to borrow a lump sum (no revolving line of credit)
- Your home secures the loan
What is a Home Equity Line of Credit (HELOC)?
Home equity lines of credit, also known as HELOCs, are a bit different from a home equity loan.
Investopedia claims the biggest difference is that “they are revolving source of funds, much like a credit card, that you can access as you choose … unlike home equity loans, they tend to have few, if any, closing costs, and they usually feature variable interest rates.”
Essentially, a HELOC gives you greater flexibility than a home equity loan. This is because you can borrow against your credit line at any time, making it a great source of emergency funds.
HELOCs also have a draw period, where you access your available credit and a repayment period that occurs when the draw period ends. There are circumstances where you can ask for an extension of the draw period. Otherwise, when the draw period ends, you can no longer access additional funds.
What are the Pros and Cons of a Home Equity Line of Credit?
Remember a home equity line of credit (HELOC) isn’t the same as a home equity loan. There are some significant differences that you’ll need to be aware of, especially since a HELOC is a revolving line of credit. In most cases, you can think of it like a credit card that you can use as frequently and as much as you want over the course of its draw period. However, because of this, here are some specific pros and cons to consider.
The Pros of a Home Equity Line of Credit
- Pay interest only on the amount you draw
- Revolving line of credit
- Low, variable interest rate
The Cons of a Home Equity Line of Credit
- You need to be careful about overspending
- Rising interest rates could increase your payment
Which Option is Right for Me? 5 Steps to Determine Your Best Option
Before you decide to apply for a home equity loan or HELOC loan, Nerdwallet advises that you consider how much money you need and how you’ll use it. Why?
Using the equity in your home can be a great way to benefit financially. However, at the end of the day, your home is being used as collateral. So, you’ll want to take these five steps to determine the best option for your financial future:
Step 1
Think about what you’ll be using the home equity loan or line of credit for. If it’s a short-term need, you may want to resist taking out funds that turn into a long-term loan. You can also use Bankrate’s home equity vs. line of credit calculator to determine the right product for your needs.
Step 2
Do your research. Go through the pros and cons. Factor in interest rates, additional and annual fees, and monthly payments to start thinking about what the life of the loan will look like. This will help you determine the best equity home loans for your financial goals.
Step 3
Make sure you consider the risks. Unfortunately, there are always going to be risks whenever you take out a loan or line of credit.
It’s best that you understand them ahead of time before you sign. Some of the risks include negatively impacting your credit score or — in some cases — losing your home. While these instances are rare, knowing this can help you avoid potential drawbacks.
Step 4
Shop around. No, we don’t mean looking at the rates and fees of major financial institutions. You’d actually be surprised at how credit unions can offer lower rates and more incentives than larger commercial banks.
Step 5
Reach out to a local team of experts. Not everyone in the banking industry is trying to trick you into a loan. Here, at First New York Federal Credit Union, we put our member’s needs first. Our team is more than willing to take the time to sit down with you to review both of our products, so you can feel comfortable and confident with your decision.
Still have questions on what to do next? If you’re a member of First New York Federal Credit Union, contact us today.
How Do I Calculate my Home Loan Payment?
Are you wondering what your payment will be? If you’re trying to factor in your interest rate, fee, and monthly payment, we have a series of financial calculators available to our members.
There are other credible calculators available for you to use from other financial institutions. For a home equity loan, we suggest Nerdwallet’s home equity loan calculator. For a HELOC, we suggest using Bank of America’s home equity line of credit payment calculator.
Still confused about what your payment will look like? No worries. When you meet with our loan advisors, they’ll walk you through exactly what your rates will look like and what options will best fit your standard of living.
Start Obtaining the Equity in Your Home: Contact Us
Deciding to move forward with a home equity loan or HELOC is not an easy, quick decision. That’s why at First New York Federal Credit Union we take the time to explain your options to you. We strive to give our members a personalized experience where they receive the information they need to pick the best decision for their financial future.
So, if you’re looking to start taking advantage of the equity in your home, don’t hesitate to contact us today.
Together, let’s help you get the best home equity loan & line of credit rates with fast approval and additional bonuses. Explore our home equity loan & line of credit product today.
*consult with your tax advisor