Sometimes life throws you a financial curveball. Maybe your credit card bills have gotten away from you, or you need to do an expensive roof repair. You need a big chunk of cash that you don’t have.
You may want to consider using the equity in your home to tap into some funds. This is called home equity debt. Your equity is the difference between how much your home is worth and how much you still owe on your mortgage.
Types of home equity debt
There are two types of home equity debt: home equity loans and home equity lines of credit, also known as HELOCs. Both are sometimes referred to as second mortgages, because they are secured by your property, just like the original (or primary) mortgage.
So, what’s the difference?
“A home equity loan is a fixed-rate installment loan where all the money is borrowed in one lump sum at inception and repaid in even monthly payments (or installments) over the term of the loan,” says Greg McBride, CFA, Chief Financial Analyst for Bankrate.com.
“By contrast, a home equity line of credit has a variable interest rate but offers a great deal of flexibility on both the borrowing and the repayment. During the initial draw period, typically 10 years, the homeowner can borrow funds only when they’re needed and has discretion over whether to make a minimum interest-only payment or to pay down the balance more aggressively.”
How to choose which is right for you
Consider what you plan to use the money for.
Home equity loans are best for those seeking debt consolidation or making a big-ticket purchase, McBride says. Because they’re a one-time loan, they aren’t subject to fluctuating interest rates, so your monthly payments remain the same throughout the life of the loan.
Eligibility criteria may be stricter for these types of loans. For example, if the value of your home has decreased, you won’t be eligible for a home equity loan.
A home equity line of credit, or HELOC, works more like a credit card because it has a revolving balance. This type of loan might be best for someone who has several large payments due over time, like with a big home improvement project,
A HELOC allows you to borrow up to a certain amount for the life of the loan — a time limit set by the lender. During that time, you can withdraw money as you need it. As you pay off the principal, you can use the credit again.
Although the money from a HELOC can be used more flexibly than a home equity loan, the amount of interest you’ll have to pay is a variable-interest rate that fluctuates over the life of the loan, which means you could end up paying steep interest charges if rates rise over time.
Things to consider with both
With either a home equity loan or a line of credit, you’re pledging your home as collateral, meaning if you don’t make the payments on your loan, the lender could end up owning your house.
Equity loans and lines of credit often have a repayment period of 15 years, although it might be as short as five and as long as 30 years.
And, even if you end up selling your house, you still have to pay off the balance of the loan before the title can be transferred.