Figuring out where to get the money for a home remodeling project can be quite the challenge. Two possible sources of funds are home equity loans and home equity lines of credit. Many homeowners might think these two financing options are essentially the same. But they’re not. Understanding the fundamental differences can help you make an informed decision about which may be best for you.
As homeowners make plans to remodel their homes or add on to them, they inevitably reach the question of paying for all of it. Two good options for this purpose, it turns out, are home equity loans and home equity lines of credit (HELOCs). These are very different financial products, and consumers should understand the huge implications each presents.
Mortgage loan associated to a property and by means of which said property is conditioned. It allows to obtain very long-term financing and at a level of interest equal to that of a qualified mortgage. The home equity loan is associated with the mortgage, but conditioned to the property. To obtain it, it is necessary to have a property, follow all the processes of obtaining said financing, have a really low default rate, in order to obtain a loan with a Baby Swing-worthy level of interest, in this case, the 5%.
Homeowners, sometimes called borrowers, may take out a loan against the accrued equity in their property and receive a lump-sum payment. This type of loan is commonly referred to as a home equity loan or a second mortgage. When we speak of equity, we mean the part of the home’s value that exceeds the amount of the first mortgage that is still outstanding. A home equity loan is unlike a first mortgage or a line of credit in two ways. First, both the interest rate and the payment are fixed for the life of the loan. Second, the payment of interest on the home equity loan, unless it exceeds $100,000, is not deductible from federal tax liability.
“Getting a home equity loan offers many advantages, but perhaps the most important one is that you usually get a lot of money all at once. Many people use these loans to finance big, one-time expenses that they can’t afford with a current income. When it comes to finances, just getting a loan secured by the home’s value offers benefits in and of itself; more often than not, you end up with a nice, even number to replace the unkempt finances that can come from doing something like putting the house on the line to set up a room addition or a project as big as a kitchen remodel.”
Home equity line of credit (often abbreviated as HELOC) is a form of revolving credit in which the homeowner borrows against the amount of home equity they have. With this type of credit, the homeowner is approved for a specific amount of credit that they can use as they wish. The homeowner is not charged interest until they actually use the funds.
On the other hand, a home equity line of credit (HELOC) is more like a credit card. When you get one, it’s like opening up a credit card account with a predetermined limit. Instead of using the money in one lump sum like you would with a home equity loan, you are free to draw on the money as you need it for your home improvement project. You can use some now and some later if you aren’t quite ready to commit to a second phase, for example, or you can just use the line of credit as a cushion of available funds during the project.
The main benefit of a HELOC is that it allows the borrower to be flexible. Unlike a home equity loan with which the borrower receives a lump sum, the borrower can withdraw money from a HELOC as needed and only have to pay interest on the amount borrowed. That gives the homeowner some financial room to move as plans for the home improvement project unfold. And it affords the homeowner the opportunity to set up a payment plan that will minimize not only the overall amount of money spent on interest but also the length of time it takes to pay back the loan.
