You’re finally ready to tear up that tacky vinyl kitchen floor and replace it with durable tile. But you realize that such a project will require loads of cash, and your money well is running dry.
What to do? Well, you have two options: HELOC or HEL.
No, we’re not talking about the fiery hot place. We’re talking about a home equity line of credit (HELOC) or home equity loan (HEL) — two ways homeowners can get cash by borrowing against their home’s equity (total value minus debt owed).
On first blush, these two acronyms look like they mean the same thing. And mostly, they do. But there are some subtle differences we’re going to explore:
A HE-what now?
So, the basics: When there’s a big purchase afoot — a major remodeling, kids’ college tuition, unexpected medical bills, etc. — homeowners can take out a home equity loan (HEL) to make it happen.
It works just like how it sounds: Borrowers get a lump sum of cash that they have to pay back within a set amount of time.
There’s also a home equity line of credit (HELOC), which functions like a credit card. With it, borrowers receive a specific amount of money — a limit, of sorts — that they can use as they need it and then pay back, usually in monthly installments (just like your credit card bill). Once the balance is paid down, the line returns to its original amount, ready for use again.
Both HELs and HELOCs are considered “second mortgages” that use the borrower’s home as collateral (more on this later).
How much money will I get?
Before they dole out the dough, lenders will assess your credit history, additional financial responsibilities (such as your existing mortgage) and ability to repay the loan or credit line.
They calculate your funds by taking a percentage of your property’s appraised value and subtracting it from the outstanding balance on your primary mortgage.
Why would I want such a thing?
Yeah, we know: The idea of MORE debt is enough to make you scream. But consider the advantages:
Since the money comes from your own equity, there’s less of a risk to borrow way more than you’re able to handle considering there’s only so much money you’re able to get, and it’s tied to the value of your house.
Plus, you get to decide how to use the money from your equity. If you prefer a wad of cash upfront that you repay at a later date, get a HEL. If you’d rather use the money like an ATM card, withdrawing funds only when you need them and repaying the balance as soon as possible, then a HELOC may be more your speed.
The not-so-great part
Do you remember earlier when we mentioned “collateral”?
Because HELOCs and HELs tap into your home’s equity — and a home is usually a borrower’s most valuable asset — you’re allowing a lender to put a lien on your property, just like your first mortgage.
And also like your first mortgage, if you fail to make your payments and default on your loan, the lender has the right to foreclose on your property (real-talk: take it away from you).
Word to the wise: If you’re still paying off your primary mortgage and dealing with other financial obligations, you better make sure another loan can fit on your plate before you start shopping around for competitive rates.
Speaking of interest rates, HELs and HELOCs have those, too.
Yet, there’s a silver lining: HELs have fixed interest rates that never change over the life of the loan, meaning your payments won’t change, either (huzzah!).
HELOCs, however, have adjustable interest rates that go up and down with federal interest rates (similar to adjustable-rate mortgages). These borrowers start out with introductory (or teaser) rates that, after a certain period of time — about six months, according to the Consumer Financial Protection Bureau — start to ebb and flow with federal rates.
More to the point, your monthly payments can change. And the payments can be interest-only, meaning you only pay the loan’s interest for a fixed period of time without touching the principal (yikes).
On a HEL, borrowers can pay down the loan’s principal and interest at the same time.
The not-so-great part, part 2
OK, breathe. We’re almost done.
But first, we need to let you in on something else you should know about HELOCs: They typically have clauses allowing lenders to cancel or freeze your line of credit.
Why would they do that, you ask? If your home’s value drops (that’s called “depreciation,” by the way), your lender may decide you’re no longer eligible to make withdrawals from your HELOC because you’re now too risky.
Did we mention the fees?
Again, HELOCs are like second mortgages and have the same upfront costs (application fees, attorney’s fees, discount points, etc.) as your first one. Be prepared.
So, which one should I choose?
Because they act as revolving lines of credit, HELOCs are best for staggered or quick costs you can repay quickly.
But if you’re looking to pay big for a one-time event, HELs offer more stability and fixed interest rates.
Either choice requires a good amount of research and confidence that your financial situation and ability to repay won’t dramatically or abruptly change during the life of the loan or line.
There’s a lot more about this topic you need to know. Feel free to talk to a loan officer for more information.