Home Equity Loans vs Lines of Credit

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Home Equity Loans vs Lines of Credit

You need to borrow money to pay for your children's college education. Alternatively, you may want to add a master bedroom addition to the top floor of your home.

One way to do so is to tap into the equity you've built up in your home.

Building up equity is one benefit of owning a home. As you pay off your mortgage, you gradually build equity. Simply put, equity is the amount of your home that you actually own. For example, if you have a house worth $200,000 and you owe $150,000 on your mortgage, you have equity of $50,000.

You can access that equity in one of two ways, through a home equity loan or a home equity line of credit.

Home equity loan

A home equity loan is a second mortgage. When you apply for a home equity loan, you'll receive a single lump sum. You then pay that sum back over a set period of years. The size of your home equity loan will be limited by the amount of equity you have in your home and other restrictions, such as the requirement of keeping some home equity available.

The interest rate attached to a home equity loan remains constant throughout the life of the loan, unless you opt for a variable interest rate.

Home equity line of credit

Home equity lines of credit (also known as HELOCs) work more like a credit card than a mortgage loan.

With a HELOC, you'll receive a set credit limit. You only pay back the amount of money that you borrow, plus interest. For instance, if you have a HELOC with a credit limit of $50,000 and you borrow $10,000 from it, you'll only have to pay back that $10,000. You'll still have $40,000 worth of credit available to you after you've borrowed the $10,000.

Which is better?

So, which product is better? That depends on the individual borrower and the individual situation.

A home equity line of credit provides more flexibility. Homeowners do not have to tap into their credit unless they need it. Because of this, many homeowners use a HELOC as an emergency fund, quick cash in the case of an emergency. A HELOC might also be the right choice for borrowers taking on a multi-year renovation project. These borrowers can then tap their HELOC when they need to write a check to move the project toward completion.

The key is to do your research before choosing either a HELOC or home equity loan. Only by studying your spending habits and needs will you be able to make the right equity decision.

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