As you consider the best strategy to manage your debt, explore the similarities and differences in home equity loans vs. lines of credit. Both are viable options to help you manage your money, and knowing the advantages and disadvantages of these options will give you the clarity you need to make the best financial decision.
Home equity loans and lines of credit use your home or property as collateral. Both loans are generally shorter than mortgages, varying in duration based on the lender’s agreement—usually between 5 and 15 years. In the case of both loans, you need to pay off the borrowed sum in full at the end of the loan or at the time that you sell your house. Robert Berger, a well-known financial blogger, suggests that you only consider a home equity loan or additional line of credit if you have paid off at least 20 percent equity in your home.
Home Equity Loans
People often refer to home equity loans, or term loans, as second mortgages. These loans are preferred for a specific purpose, such as paying for education, medical costs, or making improvements to your home. Lenders give you a lump sum of money that is then paid off over time, just like your first mortgage. You benefit from the consistency of a fixed interest rate and uniform payments every month. Once you receive your loan, you cannot borrow further.
Lines of Credit
Lines of credit work more like traditional credit cards. You can borrow a set sum of money over the course of the loan. As you pay the principal, or the money that you owe, your credit revolves. This agreement leaves room for you to borrow according to your needs, as long as you are accountable to paying down your debt. The advantage of lines of credit is lower interest rates than most loans. With this approach comes changing interest rates and fluctuating payments—the amount that you owe monthly differs based on interest rates and what you spend. The variable interest rate for any line of credit is based on the publicly available index, which you can find in most major newspapers. Be aware that many lenders create specific policies around your loan. They can limit how high or how low the interest rate will become, or require that you keep a minimal amount of debt outstanding on your credit line. Make sure to compare the fine print details of different lines of credit and always choose a contract that suits your needs.
Cost of Loans
When weighing home equity loans vs. lines of credit, we recommend thinking about the potential costs of your debt management. If you are interested in either loan, start your research by looking up the APR (annual percentage rate) of potential loans. APR is the interest rate of your loan over the course of a year. When you contrast and compare different loans, remember that APR is calculated differently for lines of credit and home equity loans. The APR for traditional home equity loans includes all financial charges relating to your loan. The APR for lines of credit does not include additional fees and costs, which are similar to those accompanying a mortgage. For maximum transparency, ask for details on all fees and costs.
Know that as you weigh your choices, you can turn toward trained counselors for support and guidance. When you decide to move forward, make sure to compare loans, read your documents thoroughly, and ask any questions you may have. Advocating for yourself will support your steps toward financial freedom.
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