For most Americans, the most valuable assets they own are their homes. Indeed, many homeowners experience a huge financial windfall when they sell their properties because of the money they have invested in it (usually in the form of a mortgage) and the increased value that has accumulated in the property over time. However, no matter how valuable your home may be, that money is not accessible as long as you continue to live in your home unless you choose to access that value — or equity — through a home equity loan or home equity line of credit (HELOC).
Let’s explore how these two popular financial products allow homeowners to leverage the value of their homes to achieve their financial goals, whether that involves investing in home renovations, funding education, or managing debt.
Understanding Home Equity
Your home’s equity is simply the market value of your home, minus the amount you owe on your mortgage. Lenders will allow you to borrow up to a certain percentage of that equity — sometimes as high as 95% — in the form of a home equity loan or HELOC. The amount of money you can borrow, as well as other terms of your loan, depends on your financial history and current obligations.
However, because home equity loans are secured loans that use the value of the home itself as collateral to secure the loan, interest rates are usually lower than rates for unsecured loans personal loans and credit cards.
Home Equity Loans
Home equity loans, often referred to as second mortgage loans, are not much different from a mortgage. You borrow a fixed amount of money paid to you in a lump sum that must be paid back at a fixed rate of interest. Home equity loans offer borrowers many benefits at times when a large sum of money is needed.
Fixed Interest Rates
One of the biggest benefits of home equity loans is the low, fixed rate of interest they offer to borrowers. Home equity loans are called second mortgages because they function in exactly the same way, offering borrowers the opportunity to lock in interest rates that last for the term of the loans, adding a fixed payment amount to their monthly budgets.
Large One-Time Expenses
Home equity loans are delivered to borrowers in one lump sum. Therefore, they are the ideal option for covering large, one-time expenses, such as a home renovation, vacation, or special event like a wedding.
Tax Deductibility
Depending on what you use the money from your home equity loan to cover, these loans may also offer tax perks in the form of tax deductions. This is especially true when home equity loans are reinvested into the property to complete renovations, improvements, or additions to the home.
Home Equity Lines of Credit (HELOCs)
Although some principles of the HELOC are the same in comparison to home equity loans — e.g., using your home as collateral to access cash — the terms and functions of a HELOC are quite different. HELOCs offer homeowners a type of flexible financing in the form of a line of credit that extends up to a certain amount. Like home equity loans, HELOCs come with their own positives and negatives.
Flexibility
HELOCs offer borrowers the ability to access a fixed set of funds for a fixed term. For example, you may be able to access up to $100,000 over the course of 10 years. As a result, these loans are flexible by nature. In other words, just because you can access $100,000, that doesn’t mean it’s required. If you only need to borrow $50,000, then you can do so and only be required to repay the $50,000 you needed with interest, rather than the full approved amount.
Variable Interest Rate
Because interest rates are constantly changing, HELOCs do not offer the same fixed rate stability as home equity loans. Instead, HELOC interest rates are variable and could rise over time.
Emergency Fund
One true benefit of the HELOC is its ability to function on an as-needed basis. Just because you can access funds doesn’t mean you have to do so. As a result, many people use HELOCs as a source of emergency funds. Basically, they offer homeowners easy access to the cash values of their homes with little risk if they don’t use the funds often.
Choosing Between Home Equity Loans and HELOCs
Choosing between a home equity loan and a HELOC is highly personal and depends on your individual needs and financial situation. In general, home equity loans are best suited for large, one-time purchases and offer some of the best interest rates available compared to any type of loan on the market.
Want to learn more? Contact Hudson Valley Community Credit Union today and get in touch with one of our lending specialists to find out what home equity options we have available to suit your financial needs.
