Taking out a home equity line of credit (HELOC) or applying for a home equity loan can provide a sensible, convenient way to access an illiquid part of your net worth — your equity in your home.
But when you do so, you’re borrowing against the value of your home and that means you’ll need to pay the money back eventually. There are obviously advantages and disadvantages to this.
Understanding why you want to use the money can help you decide if you truly need a HELOC or home equity loan. If the money is going towards home renovations or improvements, then it could increase the value of your home. If you want to use the money for something that won’t provide you with a potential return on your investment — like a vacation or new car — then you should carefully consider whether it will be worth it.
Pros and Cons of a HELOC or Home Equity Loan
There are, of course, pros and cons of these two options:
Pros of a HELOC: With a HELOC, you get a line of credit that is accessible to you whenever you need it. That gives you a lot of flexibility to use it (or not) at your convenience.
Cons of a HELOC: Aside from paying interest on whatever you borrow, there are several potential downsides to a HELOC. It can be difficult to qualify, especially if you don’t have a high credit score. If you use the money from a HELOC and can’t pay it back, you could be in danger of losing your home. For some people, having this much credit available might prove to be too tempting to resist spending it all. In other words, you should only use a HELOC if you have a specific reason for needing the money.
Pros of a home equity loan: You can receive money from your home equity in a fixed amount up front, and you get a fixed schedule of payments for paying back the loan. This can be a good option as long as you’re planning ahead and are certain you can afford the monthly payments.
Cons of a home equity loan: A home equity loan gives you cash up front, but you may have to wait a long time for that cash. You will have to make monthly payments for the entire term of the loan (often 5-15 years) and you’ll pay a significant amount of interest in that time. Failing to make your payments could result in losing your home. If you are already struggling with monthly payments on other loans, this would not be a good option for you.
HELOC or Home Equity Loan: Deciding Between the Two
If you decide that you do want to tap into the equity in your home and want a loan or a line of credit, you’ll want to determine which of these two options is best for your situation.
While they’re similar in that both allow you to access equity via a type of financing, there are some important distinctions between the two.
This chart can help you understand the biggest differences between a HELOC and a home equity loan:
The right financing option for you depends primarily on if you truly need to borrow or finance in the first place. In some cases, saving up for home renovations or keeping an emergency fund for unexpected repairs will be better for your finances in the long run.
But in some cases, HELOCs and home equity loans do make sense.
Home equity loans generally make sense for people who have a defined, one-time need for borrowing against their home’s value. Loans also allow you to receive the money you need in a lump sum, which could be beneficial.
HELOCs are good for folks who want access to what essentially works as a cash reserve on an ongoing basis. This makes sense if you have a big remodeling project and only need to pay for supplies, contractors, or other needs over time (rather than paying for everything up front).
In either case, you’ll need to repay whatever money you use. You’ll also pay interest, which adds to the overall cost of your project.
No matter what route you go, it’s critical that you only borrow or draw down what you truly need to accomplish your goals.
Do You Need a HELOC or Home Equity Loan?
Before deciding between these two financing options, make sure you truly need to take out a loan or a line of credit against the equity in your home.
If you want to utilize the equity in your real estate but don’t want to deal with interest rates or monthly payments, there is another option. You can consider a program like Unison HomeOwner, which allows you to access your equity without taking out a loan.
Unison HomeOwner will provide you with cash — up to 17.5 percent of the value of your home. You are free to use the funds however you wish. You don’t need to pay back this money in monthly payments and there’s no interest charged. Instead, Unison receives a share of the future change in value of your home.
When you sell your home, up to 30 years later, Unison would share a percentage of the appreciation that has taken place. While this isn’t the right choice for everyone, it does provide a potential alternative to a HELOC or home equity loan if you want to access your home equity but don’t want to get stuck making payments or interest charges.
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