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Which home equity loan type is right for me?
How do you decide between a home equity loan, a home equity
line of credit and cash-out refinancing when borrowing from your
home equity? You can determine this by assessing your situation
with the advantages and disadvantages of each type of loan.
There may be some situations when there is not a single clear choice
– in that case you should review your options once you have
specific loans offers. Your lending agent can also help review the
appropriateness of specific loan types for your situation and provide
detailed costs comparisons.
A home equity loan or a home equity line of credit?
A home equity loan has the following key advantages over a home equity
lines of credit: home equity loans are simpler and more stable than a line of credit, the interest
paid is fixed and they generally have less fees and charges.
A home equity loan is the more conservative home equity loan option than a line of credit and
its simplicity and stability can give you a greater peace of mind.
Home equity loans generally have a fixed interest rate and therefore fixed payments
over the life of the loan. A home equity line of credit has a variable
interest rate and your monthly payments will vary over the life
of the loan. A home equity line of credit also gives you the option
of making minimum payments on the outstanding amount – the
option to make minimum payments can really increase the interest
you will pay over the life of the loan.
Making minimum monthly payments or even partial payments that do
not fully pay off the home equity line of credit during the life
span of the loan creates a ‘balloon’ payment – a
large sum owed at the end. This situation is entirely avoided in
a home equity loan without a balloon payment option where you must make
fixed monthly payments that pay off the loan in full.
Home equity loans are free of many charges and fees common to home equity
lines of credit. These fees include transaction fees, continuing
costs (annual membership or participation fees) and inactivity fees.
With a term loan you do not have to worry about a minimum or maximum
withdrawal amounts as you do with home equity lines of credit.
A situation you want to very much avoid is taking out a home equity
line of credit for purposes of debt consolidation – absolutely
use a home equity loan instead. If you are using your home equity to pay
off debt, this may be a sign that you lack financial discipline.
A home equity line of credit works very much like a credit card
– the reason you are likely in debt in the first place. The
minimum payment option in a home equity line of credit is not conducive
to debt management and can leave you with a dangerous balloon payment
at the end of your loan.
So what situations call for a home equity line of credit? A line
of credit is the right choice when you need to access money at intervals
or you do not know exactly how much money you will need. College
tuition payments over the next four years is an example where money
is needed at intervals. An open-ended repair or home improvement
job on your home that spans a long period of time is an example
where you may not know exactly how much money you will need. In
both of these situations, you benefit by using the money only when
it is needed.
Home equity lines of credit generally have a lower interest rate
than home equity loans. Home equity lines of credit are also
a good choice if you are borrowing a small amount and you know you
will be paying it back quickly.
A home equity loan or cash-out refinancing?
Refinancing has the advantage of a lower interest than a home equity
loan but it has the disadvantage of having higher closing costs.
A home equity loan generally has a shorter term than refinancing
a mortgage – this can favor home equity loans if the shorter
term results in less interest paid. Refinancing usually takes a
few weeks longer to close than a home equity loan.
You should only consider refinancing if your refinancing interest
rate is lower than your current mortgage. The lower refinancing
interest rate will lower your monthly payments. The savings in lower
monthly payments will have to recover the money spent in the closing
costs of refinancing before you sell your home. If this is not the
case, refinancing is not for you.
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