Building equity in your home is a gradual climb. Home equity is the difference between the value of your home and the amount you owe on your mortgage. The amount of equity you hold in your home can increase in two ways: through an increase in your home’s value or through paying down your mortgage.
One of the benefits of building equity in your home is the ability to borrow money while using it as backing. These lending options can be incredibly beneficial for those who are looking to finance home improvements, maintenance, and repairs or cover expenses in an emergency.
There are two main lending options using your equity: home equity loans and a home equity line of credit (HELOC). This is a lending option where the bank will put a lien on your home to secure the loan or line of credit. Below, we will explore each, including the differences between the two and how each can be beneficial.
Home Equity Loan
One option for borrowing against the equity you have in your home is a home equity loan. A home equity loan provides a lump sum of cash at the time of closing, with a fixed interest rate and fixed monthly payments throughout the life of the loan. Repayment terms can be as long as 15 years. Furthermore, these loans typically have lower closing costs than a traditional residential refinance.
Because the loan is secured with your home as collateral, you will often receive a more favorable interest rate compared to an unsecured personal loan.
The favorable interest rate means you can allocate more for those perfect upgrades you envision, including energy-efficient upgrades, maintenance, and repairs. Or consolidate higher-interest loans, such as a personal loan or credit card debt and apply more of your payment towards the balances you owe and less to interest.
Home Equity Line of Credit
A HELOC is a two-phase lending option, using the equity you have in your home as backing. As opposed to the lump sum payout of a home equity loan, a HELOC grants access to an ongoing, revolving line of credit for up to 10 years, during what is called the draw period.
During the draw period, you will be required to make interest-only payments, though you can also choose to pay down principal at any point, for any amount. This can be a convenient way for you to repay the principal amount at a payment that you’re comfortable making. As you pay down parts of the principal, you regain access to that money until the draw period ends. Think of this in terms of how a credit card operates, providing an open line of credit with a set limit. Interest is applied monthly to the funds that are used, and it continues to accrue until the full amount is repaid.
Once the draw phase has ended, a 10-year repayment period will begin. During that period, you will make amortized payments until the principal balance and interest are paid off. For HELOCs, the interest rate of the loan is subject to change with the ebb and flow of the Federal Reserve rates. The HELOC rate is based upon the Wall Street Journal Prime Rate. As with a home equity loan, a HELOC will usually offer a better interest rate than unsecured lines of credit.
A HELOC is a great option for anyone who is looking to make a series of home improvements over an extended period of time, those with higher-priced maintenance or repair projects to complete, or someone looking for a supply of cash to cover emergency expenses.
Understanding the differences between home equity loans and home equity lines of credit is essential when making informed financial decisions. Both options offer valuable ways to tap into your home’s equity, but they cater to different financial needs and situations. Whether you require a lump sum for a significant expense or a flexible credit line for ongoing projects, making the right choice can help you maximize your financial potential.
Community First Bank and HFG Trust is here for you when you’re ready to take the next step towards leveraging your home’s value and guide you to the best options that fit your financial goals. Our team of experts, from Mortgage Consultants to Personal Bankers, offer personalized solutions tailored to your financial landscape. If you have any questions, or are ready to explore these options more in-depth, contact us today.
Andrew Bellon, NMLS ID #1704570, Private Banking Relationship Manager
