Homeownership is a wonderful way to build wealth over time, but there are also other perks, including the ability to tap into your equity for large expenses. The equity in your home is equal to the value of your house less what you owe on your mortgage and any other liens on your property. It is the value of your house that you own outright.
Home equity loans and home equity lines of credit (HELOCs) can be used to access the equity in your home. Throughout this article, we’ll discuss these two programs and determine which is best for you.
What is the best way to build home equity?
Defining Home Equity Loans
A home equity loan gives you access to the equity in your house. The funds from a home equity loan will be provided to you in one lump sum, and will then need to be repaid in fixed instalments plus interest, just like an instalment loan. You’ll also be given an exact schedule of when you must make payments.
The terms of paying back the borrowed equity vary from one lender to another. Defaulting on a home equity loan means that your home is at risk if you cannot make your payments, similar to a typical mortgage.
Based on how much equity you possess and how much your lender will loan, you can borrow a certain amount on a home equity loan. For this type of loan, you typically need at least 20% equity in your home, meaning you could borrow up to 80% of its value. You may be able to borrow more, but the interest rate will likely increase as the amount of the loan increases.
Some pros of Home Equity Loans are that they provide funding for large expenses, and have both a fixed monthly payment that is predictable as well as a fixed rate of interest. In addition, consolidation of debt and lowering of existing debt interest rates are possible.
- You risk losing your home if you default
- Higher interest rates than HELOCs (although lower than other loan types)
When is it best to use a home equity loan?
Home equity loans can be useful in a number of circumstances. With this type of loan, you can basically use the funds however you want, although certain expenses are better than others.
An equity loan may be the best option to cover the cost of renovations. A project that increases the value of your house is money well spent. Depending on how much value is added to the project, many projects will produce a decent return on investment so that you will be able to recoup most or all of your investment.
Consolidate Your Debts
Another reason that homeowners take out equity loans is to consolidate their debt. Due to the fact that home equity loans generally have lower interest rates than typical personal loans (because your home is collateral), you can use the equity from your home to settle any other debts you have, including high-interest debts. With only one loan, you can both save money and manage your debt more easily by securing a lower rate and consolidating several loans into one.
In Case of an Emergency
If an emergency expense arises, you can always use your home equity to pay for it, such as a last-minute car repair. That said, it’s important to be careful about how you use your money. Frivolous expenses shouldn’t add to your debt load. As you’re putting your house at risk, you want to make sure you’re using the money wisely and repaying it as soon as possible.
Definition of HELOC
In the same way as a home equity loan, a home equity line of credit (HELOC) leverages the equity in the home to lend money. HELOCs, on the other hand, are a form of credit line that enables you to access a certain amount of equity in your home, much like the use of a credit card.
The HELOC allows you to borrow against a set credit limit whenever you require additional funds. Just like a credit card, you can borrow against that available credit when needed. In addition, you do not need to borrow against it at all, and you can let months elapse between withdrawals. When you do need credit, though, it’s there for you.
- The interest is only calculated on the amount withdrawn
- You can access funds at any time
- Excellent flexibility
- Every time you need extra cash, you won’t have to apply for a new loan
- The loan has a lower interest rate because your home serves as collateral
- If you default on your mortgage, your home is at risk
- Budgeting payments is more challenging
- An increase in interest rates is possible
- Payments require self-discipline
- Lenders have the discretion to reduce your credit limit
When is a HELOC the best option?
HELOCs are not traditional loans because you cannot receive a lump sum payment that you must repay on a regular basis as is the case with conventional loans. Depending on what you want to do with the money, you can update your home, make car repairs, or even take a vacation or invest in an opportunity.
In reality, a HELOC may be a better choice for those with sporadic expenses that need a little extra help. A HELOC allows you to borrow funds at any time rather than having to apply for a new loan every so often. The only thing you need to do is to withdraw the exact amount of money needed to cover the expense and then just be charged interest on it. Your money can be accessed repeatedly once it has been repaid.
Which is better, a HELOC or a home equity loan?
According to your situation, you will choose a specific loan type. The best choice for you might be a home equity loan if you need a one-time loan to pay for a large expense, such as remodelling your home, and you like the idea of predictability. If, however, you need to borrow funds from time to time without having to apply for a new loan each time, then a HELOC might be a better option for you.