You need some extra finances and the decision boils down to home equity loans vs. lines of credit. Your specific financial situation determines the best choice for your borrowing needs.
Home Equity Loans vs. Lines of Credit Overview
A home equity loan is a second mortgage based on the amount of equity in your house. It comes as a lump sum with a fixed interest rate and a fixed payment over the life of the loan.
A home equity line is a line of credit based on the amount of equity in your house. It can come in the form of a checkbook or credit card, which allows you to borrow up to a certain amount of capital. You don't get the money all in one lump sum like an equity loan; you borrow funds as you need them. Your interest rate (in most cases) and payments will vary depending on current rates and the account balance.
While this is the simple explanation, there are many factors that determine which choice is right for you.
Line of Credit Advantages
There are many home equity line of credit advantages that can be used for your specific borrowing needs.
- Interest Rates - A home equity line of credit rate usually starts a bit lower than equity loan rates. Rates are usually variable and based on the Prime Rate. As rates go lower, so will your interest rate and payment.
- Flexibility - Borrow what you want, when you want. This keeps you from borrowing in excess, which keeps your payments down. It also allows you to be conservative on your budgeting. You can borrow what you need, as in a home improvement project, but if you need more, you don't have to take out another loan, just tap your equity line of credit.
- Taxes - The interest portion of your payments are tax-deductible, and while the principal is not tax-deductible, it is not considered income, so it won't hurt your tax bill either.
Home Equity Loan Advantages
When comparing home equity loans vs. lines of credit, a home equity loan is not without its advantages either. There are many aspects of this type of loan, which may be perfect for your financial situation.
- Interest Rates - As opposed to a variable interest rate with an equity line, a home equity loan has a fixed rate. And while rates may go down, they may go up, too. If rates go up, your rate will remain fixed and steady giving you an advantage during times of increasing rates.
- Immediate Needs - Getting your home equity loan in one lump sum is a benefit for projects that require up-front costs. If you need money immediately for something like an addition to your home or other major remodeling projects, an equity loan provides the large amount of cash you need right away.
- Stability in Your Budget - Equity lines have varying rates, balances, and payments. This makes budget forecasting a bit tricky. With a fixed rate loan, you have stable payments over the life of the loan allowing you to balance your budget.
- Taxes - As with an equity line, your interest payments are tax-deductible and your principal is not considered income, keeping your tax bill within a manageable range.
The Home Equity Loans vs. Lines of Credit Decision Process
You've seen both sides of the coin and weighed the benefits of home equity loans vs. lines of credit, but there is still one more step in the decision process - costs. In determining which type of loan is the best fit for your situation, you should be aware of the costs for each process.It is important to look at the annual percentage rates (APRs) for a loan and a line, but keep in mind that the APRs are calculated differently for each.
- APR for an Equity Loan - Includes interest rate plus points and other finance charges.
- APR for Equity Lines - Does not include points or charges. Calculated only using the periodic rate.
In deciding between and equity loan and an equity line, make sure you factor in the rates, points, and any associated fees to open the accounts. This should all be part of your decision-making process.
Do keep in mind that all fees, points, and rate information should be disclosed to you before you sign any loan agreement. You are protected under the Truth In Lending Act, which requires by law for lenders to inform you of all pertinent terms in your agreement. This Act also protects you if lenders change anything like rates or terms between the time you inquire about the agreement and open a plan. You also get three days to cancel the plan in writing if you decide the terms are not for you, and no lender may change any of the terms of your loan once it is open for any reason.
Knowing is Half the Battle
The home equity loans vs. lines of credit battle is not as prolific or complicated as it may sound. Once you understand the construction of each type of loan then it just comes down to picking the plan that is best tailored to your financial needs. Always borrow responsibly and do your best to make regular and timely payments if possible.
