Home Equity Loan or Line of Credit? How To Decide Which is Right For You

Homeowners build equity in their properties with every monthly mortgage payment they make on time and in full. That means you start accruing equity from the first payment, and after a few years you may have enough to consider tapping for funds. This can help you pay for expenses like home remodels or even save for college.

When looking to leverage their home equity, consumers have two main options: the home equity loan and the home equity line of credit (HELOC). Both are commonly offered by banks and other lenders, and each can allow you to meet various personal financial goals.

Here's a primer to deciding which is best for your needs:

A couple things about home equity

While home equity loans and HELOCs differ in some respects, they share fundamentals. They are both lending products that are made based on equity held in a home. The first thing you can do is identify how much equity you hold in your home. This is done by subtracting the amount that is outstanding mortgage form your property's value. If you have a home appraised at $500,000 and a mortgage with $375,000 remaining, your equity is $125,000. 

However, lenders will usually only make about 80% of that equity accessible — depending on other factors like loan-to-value and debt-to-income ratios. Another important aspect to consider is that for home equity loans and lines of credit, your residence is your collateral. This may qualify you for lower rates, but it also means you risk losing your home if you default.

Knowing this, be sure to use home equity funds for cost-effective purposes. Avoid using such loans to pay for personal purchases, as property values fluctuate with the housing market, potentially complicating repayment and your equity position.

With these considerations in mind, let's look at the options themselves.

Home equity loan

Home equity loans are lump-sum loans made to homeowners at a fixed interest rate. Monthly payments are consistent and you can budget for big, one-off expenses. Terms usually stretch for five to 20 years. Some worthy uses of such a loan may be:

• Major renovation projects that increase the value of your home.
• Consolidating or paying down high-interest debts.

However, one thing to keep in mind is that once you take out the loan, it's yours: The entire sum is dispersed and you will need to start paying it back immediately. There are also closing costs to consider.

Home equity line of credit

HELOCs function much like credit cards: You qualify for a balance based on your home equity (rather than your credit profile), and you can draw from that account, paying it back as you go at a variable interest rate. HELOCs are generally structured in dual 10- or 15-year periods: The first is the draw period, the second is the repayment period. During the first phase, you only pay interest on the draws you make, the principal doesn't have to be paid back until later. This makes it a good use for:

• Saving for college or meeting the costs of higher education.
• Having on standby as emergency savings.

HELOCs also have closing costs to consider, as well as the possibility for your interest rate to rise.

Want to learn more about the options and how you can use your home equity? Contact your local Vectra Bank representative today.