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If you have equity in your home and are looking for a way to access it, you may be looking at opening a Home Equity Line of Credit (HELOC) or Home Equity Loan but wondering what the difference is between them and how to choose the right one for you.
Before we talk about the differences between a HELOC and Home Equity Loan, we must discuss the similarities. For starters, both types of loans use the equity you have earned in your home as collateral, usually making the interest rate lower compared to personal loans and credit cards. Equity is the difference between what you owe on your mortgage and the home's market value. For example, let’s say you bought your house for $200,000 and after ten years of making payments, you now owe $100,000 on the mortgage loan. Your home also increased in value over the ten years and is now worth $250,000. You would then have $150,000 of equity in your home (your home’s current value of $250,000 minus what you owe $100,000).
A HELOC (Home Equity Line of Credit) is a revolving line with variable interest rates, similar to a credit card. Since HELOCs work like a credit card, you can pull from them when you want, up to the amount of your credit line. Due to the credit line having a variable rate, your payments can change month-to-month. Once you pull funds from your HELOC, the funds you borrowed will start to incur interest. During the draw period of your loan (the time that you can borrow funds), you will only be required to pay on the interest of the loan. After that initial period, you will enter the repayment period and be required to pay off the interest and principal balance; this will increase your payment.
A HELOC may be the right option for you if: you don’t know how much you want to borrow or want to have a credit line set up for emergencies with a lower rate than a credit card, and you don’t mind fluctuating payments or the potential of your rate increasing. A HELOC may not be the right option for you if: you want to know your exact payment month-to-month, you are prone to overspending, or you don’t like the thought of your rate fluctuating.
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Often called a second mortgage, a Home Equity Loan is a fixed-rate loan that allows you to borrow a one-time lump sum. This type of loan provides you with a fixed payment and fixed interest rate, ensuring that your monthly payment will remain the same each month.
A Home Equity Loan may be the right option for you : you have a specific cost in mind and want a predictable monthly payment. A Home Equity Loan may not be the right option for you if: you don’t know how much, or when, you will need to withdraw the funds, and you’re worried about property values declining in your area.
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