When to use a home equity loan or line of credit
Your home is your biggest financial asset and your largest source of financial strength. Why? Because your home has equity.
So, what is home equity, anyway?
To determine your home equity, subtract outstanding first and second mortgage loan balances from your home's market value. Home equity is the portion of your property that you actually own. And while it's true that your lender doesn't own any portion of your house (it's all yours), if you're making monthly payments against a loan, your home is the collateral. Until the loan is paid in full, the lender can control what happens to your home in the event of missed payments.
When you have equity in your home, you can leverage it to meet different financial goals throughout your lifetime. There are two main home equity tools you can use in different scenarios:
- Home equity line of credit
- Home equity loan
Discover the difference between the two and how should you utilize these solutions below.
Home equity line of credit
When you take out a home equity line of credit, you're using the equity of your home as collateral for the credit line. You are only required to pay the interest each month on what you use. The interest rate is variable based on the market. A home equity line of credit is continually re-usable and has an interest-only minimum payment. So, you have the flexibility to decide whether to make small or large payments depending on your individual circumstance.
A home equity line of credit can be used if you:
- Have a short-term financial need.
- Are in the market for a new home
- Want to consolidate debt.
- Have a home improvement project to accomplish
Interested in buying a new home? Your home equity line of credit can double as a down payment on a new home, or act as a bridge between two homes during the selling and buying process. The line of credit can also act as an emergency reserve. You can access it when unplanned expenses arise.
Home equity loan
Unlike a home equity line of credit, home equity loans have a fixed interest rate, term and scheduled monthly payment. A home equity loan may be a more fitting solution if you want a fixed payment, with a specific payoff date. You can choose from a variety of term-loans including 15-year, 10-year, 5-year or 3-year. Home equity loans are not reusable and should never double as an emergency reserve.
A home equity loan can be used if you:
- Have a fixed budget for a remodel or home addition.
- Want to consolidate or pay off debt with a new or fixed interest rate.
- Are preparing for a large purchase.