You’ve built equity in your home — that’s great! Home equity is value that you can access while you still own your home. That could include taking out a new loan, taking a home equity loan or opening a home equity line of credit, which is commonly referred to as a HELOC.
But what’s the difference between the options? Here’s a look at each to help you understand what might work best for your situation.
HELOC vs. home equity loan: What’s the difference?
Let’s begin with the similarity between a HELOC and a home equity loan. Neither of these options would be a traditional first mortgage on your home. In fact, they’re usually in addition to your first mortgage. That means, if you like the terms of your first mortgage, you can continue to pay that mortgage while also taking out a home equity loan or a HELOC.
The difference between the two is how you get the money from the loan.
What exactly is a HELOC?
A HELOC is a line of credit. It basically works like a credit card. You’ll have a maximum amount that you can borrow and you can draw as much or as little as you’d like. You’ll owe a minimum monthly payment on any amount you draw, and you’ll also have the option to pay more. While you will owe interest on any outstanding amount, because the loan is secured with your home equity, the interest will be substantially less than what you’d pay to carry a balance on your credit card.
With a HELOC, you typically have a draw period, perhaps for 10 years. Once your draw period is over, you will no longer be able to access your home equity, and you will need to begin paying down your debt.
A HELOC can be a great option if you’re looking for some flexibility with how and when you access your home’s equity.
What is a home equity loan?
A home equity loan is similar to a HELOC as it allows you to access the equity you’ve built in your house. But whereas a HELOC allows you to draw from a line of credit as you need, with a home equity loan you are paid a lump sum of money all at once.
Another important difference between HELOCs and home equity loans is that home equity loans typically have a fixed interest rate rather than the variable rate you’d typically find on a HELOC. In addition, home equity loan payments are fixed and set more like a traditional mortgage. This means your monthly payments will remain the same over time regardless of how interest rates change, which can make it easier to budget and repay your loan over time.
Since you’ll get a one-time payment with a home equity loan, this can be a good option if you have a specific use for the funds like remodeling or paying off high-interest debt.
Cash-out refinance vs. HELOC
A cash-out refinance is another option to consider when tapping the equity in your home. A cash-out refinance is a new loan that replaces your existing mortgage — unlike a HELOC or home equity loan, which would typically be a loan in addition to your existing mortgage.
A cash-out refinance is similar to a traditional refinance, where the total amount that you owe stays about the same, while the terms of your loan (interest rate, repayment schedule, etc.) change. With a cash-out refinance, the total amount that you owe will actually increase. That’s because you’re tapping into your home equity. After paying off your current loan, you receive the difference between what you owed on your original loan and what you will owe on the new loan (the cash-out).
A cash-out refinance can be a good option if you’re looking for the simplicity of having a single loan and payment. Cash-out refinancing is typically best when you have a specific need for the money such as for remodeling or paying off high-interest debt. Another consideration is the interest rate on your current mortgage. If you are getting a better or similar rate a cash-out refinance may be the best option. However, if the interest you’d pay is higher, a home equity loan may make more sense.
Tapping into your home equity
Home equity loans, HELOCs and cash-out refinances can be appealing because they offer a way to access and leverage the equity that you’ve built in your home — typically at lower interest rates than other forms of debt. Why? Because they are secured by your home, which essentially acts as a form or collateral that reduces the amount of risk taken on by your lender.
No matter what type choose, it’s important to understand the terms of the loan and to be comfortable that you’ll be able to make the payments. If you’re thinking about accessing the equity that you’ve built in your home, a financial advisor can work with you to show you how the decision fits into your overall financial plan.