One of the biggest advantages of home ownership is that a house is an investment. With each passing year, you owe less on your mortgage and – more times than not (hopefully) – the home value increases. There may be times when you may need to dip into this equity to help with some of life’s bigger expenses.
There are two ways to leverage the value of your residence – a home equity line of credit (HELOC) and a home equity loan. Before deciding on either, it is important to know that you should only consider these options if your mortgage is less than 80 percent of the home’s value. If you fall in that category, understanding the differences between the two ways to borrow is important.
HELOC or Home Equity Loan?
Essentially, a home equity loan is a second mortgage on your house. Once you’re approved, the lender will send the entire loan amount via a check or wire transfer to an account you designate. Payments – including interest – are made each month over a fixed term, a manner similar to your existing mortgage or a car loan.
With a HELOC, you do not receive one lump sum of cash. Instead, the lender gives you a line of credit that is available on an as-needed basis. Typically, HELOCs have an adjustable interest rate associated with the loan. Some, such as those offered by NVE Bank, have a fixed rate during the draw period.
Advantages of HELOCs
The “revolving” credit of a HELOC offers many benefits for a home owner. First, knowing that money is there when you need it provides a level of flexibility and security you don’t enjoy with a home equity loan. Second, unlike your credit card, a HELOC is considered a secured debt because your home is working as collateral, ultimately creating a lower interest rate for your payments. Finally, as an added bonus, you may be able to claim your HELOC as a tax-deduction. As with all tax matters, you should consult your accountant or financial advisor.
Before taking advantage of the borrow-as-you-need approach associated with a HELOC, certain aspects should be considered. Here are four:
- Interest Rate – As we stated earlier, many HELOC plans have a variable interest rate. This factor is particularly important in 2016, as the Federal Reserve has announced it plans on raising interest rates this year. So, if you are considering a HELOC the time to act is now.
- Understand Payment Terms – Before committing to a HELOC, it is important to know how you will pay back the borrowed money. Avoid plans that are set up so all the interest is paid before any money is applied to the principal. Select a HELOC in which each payment reduces both the principal and interest amounts. Additionally, be sure to understand the conditions for renewal of the plan or for refinancing if you have an unpaid balance at the end of your loan period.
- Advance Period Terms – HELOCs with these terms allow you to access the money for a set period of time. Once that term is up, you can’t withdraw money and you must repay whatever you borrowed over an extended time span. This is generally known as the “repayment period.”
- Balloon Payment – Some HELOCs have an additional large fee due at the end of the loan’s terms. Many times, this balloon payment is so exorbitant that you may have to refinance it so it fits into your budget.
When to Use a HELOC
A good rule of thumb when considering a HELOC is that the money should be used for what you need compared to what you want. One of the most popular uses of HELOC funds is for a home improvement. Renovations are particularly a smart investment when you are planning to sell your home in the near term, as you can pay the HELOC off quickly and your house is more attractive when it’s on the market. Other major purchases, such as cars and appliances, as well as college tuition are also high on the list of things to pay with the loan money.
Less popular options are lavish weddings or exotic vacations. Some people also consider using it for paying down credit card debt, as HELOCs typically have a lower interest rate. This approach is only advisable if you plan on adhering to a budget or you may find yourself back in the red a few years down the road.
The bottom line is turning home equity into cash needs to be done with great care. It is best to review your options and discuss it with a professional. NVE Bank has a variety of HELOC plans to accommodate your personal needs, as well as Lending Specialists who can help you select the best option for your particular situation.
Want more information? Visit our website to learn more about our loan options and rates or call 1-201-816-2830, ext. 1230 to speak to one of our Lending Specialists.