The time has come and you have decided to tap the equity in your home. In shopping products you study some differences betwwen Home Equity Loans and Lines of Credit but may still have some questions as to which product best fits your needs.
Every situation is different and it is hard to say that one product has more benefits than another in any given circumstance, but there are some questions you can ask yourself that may help guide you to your best fit.
Q: Does a variable rate bother me?
Most Home Equity Lines of Credit have a variable rate based on the Prime Rate Index, as posted in the Wall Street Journal, whereas most Home Equity Loans have a fixed rate throughout the term of the loan. If you pick a Home Equity Line of Credit, the rate from month to month may fluctuate. Most Home Equity Lines of Credit are also interest only, meaning it only bills for the interest owed during the draw term. In effect, if the Prime Rate goes from 4% to 8%, this means as the rate doubled, so did the monthly payment. Over a 10-year window, the prime rate tends to carry a lower rate than a fixed rate, but you must be wiling and able to withstand the peaks and valleys.
Q: Do I need the loan proceeds in one lump sum or over several installments?
If you need the funds in one lump sum, you can accomplish this with either product as the Home Equity Loan gives you all funds at once and the Home Equity Line of Credit allows you to draw as needed. If you need the proceeds over several installments (as common with home improvement projects, tuition expenses, etc...), it may be best to go with the Home Equity Line of Credit. With a Home Equity Line of Credit you only pay interest on money that you have already borrowed. If you don’t use it there are typically no interest charges. With a Home Equity Loan, typically finance charges begin to accrue the day the loan is established.
Q: Would a Home Equity Line of Credit tempt me to use the money more carelessly?
If you are taking out a Home Equity Loan or Line of Credit to payoff credit card debt, you may want to consider if lines of credit tempt you to spend carelessly. If so, you may want to go with a Home Equity Loan with an appropriate loan amount where payments are structured and there isn’t the ability to keep drawing. Keep in mind, you home is on the line and you don’t want to spend carelessly and risk not being able to make payments.
Q: How much can I afford?
Home Equity Loans typically bill both interest and principal every month whereas Home Equity Lines of Credit typically only bill interest during the draw period. This means by borrowing the same amounts with either product, a Home Equity Line of Credit monthly payment will be lower during the draw period. Keep in mind, the principal will be due at some point and provisions should be made to repay the loan. However, interest only payments may help accomplish a short-term goal.
In general, Home Equity Loans tend to be stable. The interest rate and monthly payment is stable making this an easy loan to plan for and budget. Overall, the Home Equity Line of Credit tends to be more flexible with a flexible interest rate, payment method, and ability to draw up to the credit limit when needed.
When shopping for Home Equity Loans or Lines of Credit, there is a lot to consider. The above questions are only a few basic points to consider. Again, every situation is different and lends itself to a whole new set of circumstances.