Has your mind been on home improvement or other large expenses? Your home may be a financial goldmine just waiting to be tapped. The equity you’ve built up, which is the difference between what your home is worth and what you still owe on your mortgage, can be a powerful tool to help you achieve your goals. It can be ideal for remodeling your kitchen, paying for college tuition, or consolidating debt.
When you start looking into using your home’s equity, you’ll likely come across two main options: a fixed home equity loan and a Home Equity Line of Credit (HELOC). They might sound similar, but they’re different, each with its own set of strengths and weaknesses. A bit confused as to whether a home equity loan or a home equity line of credit (HELOC) will better fit your needs? Let’s go over the differences to help you decide.
What’s a Fixed Home Equity Loan?
Think of a fixed home equity loan as a second mortgage. When you get one, you receive a lump sum of cash all at once. It’s a one-and-done deal.
You apply for a specific amount, and if approved, the full amount is deposited into your account. Then, you start making regular, fixed monthly payments over a set period. The term is typically 5, 10, or even 20 years.
The most important thing to know about this type of loan is that the interest rate is fixed. Your monthly payment will never change, no matter what happens in the economy. It’s predictable and stable, which can be a welcome relief if you’re someone who likes to budget with certainty.
Strengths of a Fixed Home Equity Loan
- Predictable Payments: As we just mentioned, a fixed rate means your payment is the same every single month. It’s easier to budget and plan for the future.
- Structured Repayment Plan: You have an end in sight with a final payment date.
- Disciplined Spending: Since you receive all the money upfront, you can plan accordingly. It encourages you to stick to a plan. It’s perfect for larger one-time expenses where you have a clear idea of the total cost.
Weaknesses of a Fixed Home Equity Loan
- Less Flexibility: Once you get the money, that’s it. If your project costs more than you anticipated, you’d have to go through the whole loan application process again to get more funds.
- Immediate Interest Accrual: You start paying interest on the full loan amount from day one, even if you don’t need all the cash immediately.
When to Use a Fixed Home Equity Loan
If you need funding for a one-time project or a considerable expense, a home equity loan is the better option.. It’s a good option for borrowers who want the security of a fixed-rate loan, a fixed term, and a fixed monthly payment. Your loan is paid back in installments each month, making it easy to budget for a specific monthly payment. A home equity loan is ideal for larger expenses such as the following:
- Home remodeling project being completed all at once
- Debt consolidation
- Vacation
- Medical expense
- Wedding expense
- College tuition
- Vacation home
- A large purchase
Scenario 1: The Dream Kitchen Renovation
You’ve been dreaming of a new kitchen. You’ve gotten bids from contractors, and you know the total cost will be around $45,000. With a fixed home equity loan, the entire $45,000 is provided to you in one lump sum. You can pay the contractor in full, have a predictable monthly payment for the next 10 years, and enjoy your new kitchen without worrying about rising interest rates.
Scenario 2: Consolidating High-Interest Debt
You have several credit card balances with high interest rates, and the monthly payments are unpredictable and stressful. You could use a fixed home equity loan to pay off all those cards at once. Debt consolidation simplifies your financial life by replacing multiple, high-interest payments with one single, lower-interest payment. You’ll know exactly how much you’re paying each month and when you’ll be debt-free.
What’s a Home Equity Line of Credit (HELOC)?
Think of a HELOC more like a credit card, but with a much lower interest rate and a higher credit limit. You’re approved for a maximum credit limit, but you don’t receive all the money at once. Instead, you have a “draw period” (usually 10 years) during which you can withdraw cash as you need it, up to your approved limit. You only pay interest on the amount you’ve actually used.
The key difference here is the interest rate. A HELOC typically has an adjustable rate, meaning the interest rate can go up or down over time, based on market conditions. Meaning your minimum monthly payment can fluctuate.
Strengths of a HELOC
- Unmatched Flexibility: You can draw on your credit line whenever you need cash. It’s fantastic for ongoing projects or unexpected expenses.
- Pay Only for What You Use: You’re not paying interest on the full approved amount, just on the portion you’ve borrowed. If you don’t use any of it, you pay nothing (though some HELOCs have a small annual fee, so be sure to check).
- Revolving Credit: As you pay down the balance, the credit becomes available again during the draw period, just like a credit card.
Weaknesses of a HELOC
- Adjustable Interest Rate: This is the big one. Your interest rate can change, which means your minimum monthly payment can go up, making budgeting a bit trickier.
- Can Be Tempting: With a line of credit available, there’s a temptation to use it for non-essential purchases, which could lead to overspending.
- Two-Part Repayment: Many HELOCs have a two-phase repayment structure. The draw period, where you might only be required to make interest-only payments, is followed by a repayment period, where you must pay both principal and interest. It’s crucial to understand how this transition will affect your budget. Benchmark FCU offers members two great repayment options for their Ultimate HELOC, making it a strength for many borrowers. Tap to see the differences in repayment for a Benchmark HELOC.
When to Use a Home Equity Line of Credit
Those with larger expenses spread out over time may find the benefits of a HELOC much more appealing. When you apply for a home equity line of credit, you have access to an approved limit of cash, but you don’t need to pay any interest on the money until you start to withdraw it from the line. It’s great when you don’t need the funds all at once. Your payments are based on the balance you withdraw, rather than the total of your approved amount. The line allows you to draw funds when you need them. As you pay down the balance, you can continue to reuse the line for the entire draw period. There will be a pre-specified draw period and repayment period. You also have the peace of mind in knowing you have access to funds in the event of an emergency. A HELOC is ideal for borrowing needs, including:
- Home improvement projects spread out over time
- Ongoing educational expenses
- Consolidation of debt
- Emergency or unexpected expenses
- Large expenses
- A combination of different expenses
Scenario 1: Ongoing Home Repairs or Upgrades
Let’s say you have a few home projects you want to tackle over the next couple of years. Consider a new roof, a bathroom remodel, and new landscaping. You don’t want to take out three separate loans, and you don’t have a firm budget for all of them yet. A HELOC is perfect in this scenario. You can take out a little bit of money for the roof, pay it down, and then use the available credit for the bathroom and the landscaping when you are ready. You only pay interest on the amount you’ve withdrawn.
Scenario 2: College Tuition Payments
Tuition payments happen on a semester-by-semester basis. Instead of taking out a large loan at the beginning, a HELOC allows you to withdraw funds as each semester’s bill comes due. You will only be paying interest on the funds you’ve actually used, which can save you a significant amount of money over time.
Finding the best deal on a Home Equity Loan
No matter which option you choose – a fixed home equity loan or a HELOC – it’s smart to shop around for the best terms.. To compare apples to apples, you will want to know all the costs and fees involved in paying for the loan, in addition to the interest rate. The lowest interest rate does not always equal the best deal, especially when high fees are involved.
Here’s what to keep an eye out for:
- Interest Rates: While fixed rates offer stability, you still want the lowest one possible. For a HELOC, look at the initial “teaser” rate and the “index” rate it will adjust to.
- Fees: Ask about application fees, appraisal fees, and closing costs. Some lenders, like your local credit union, might have lower fees or even waive them entirely.
- Repayment Terms: For a fixed loan, understand the length of the repayment period. For a HELOC, make sure you’re clear on the draw period, the repayment period, and any potential interest-only payment options.
Tap to read the details of a Benchmark home equity loan vs. the ultimate flexibility of a Benchmark HELOC.
Your Credit Union Might Be Your Best Option
When you’re ready to explore your options, don’t overlook your local credit union. Unlike big banks, which focus on maximizing profits for shareholders, credit unions are non-profit financial cooperatives owned by their members. This difference in structure can lead to some significant advantages for you:
- Lower Rates and Fewer Fees
- Personalized Service
- Trust and Community Focus
Because Home equity loans and HELOCs are secured using your home as collateral, they usually offer lower interest rates than unsecured loans and other types of debt. They are a good choice for consolidating higher-interest debt and high-interest credit card balances. Used responsibly, with a focus on making your monthly payment on time every month, a home equity loan or a HELOC can be a great financial tool in helping you realize your financial goals. When used irresponsibly, however, they can put your home in danger of foreclosure. Your house is, after all, the collateral for the loan. You must be sure you can make the payments before borrowing. You also want to avoid the temptation of using a HELOC for items you don’t need. That can quickly lead to financial trouble.
Making the Best Choice for You
Ultimately, the choice between a fixed home equity loan and a home equity line of credit comes down to your personal needs and preferences.
- Choose the fixed home equity loan if: You have a specific, one-time expense with a clear cost, you want the stability of a predictable monthly payment, and you prefer a defined repayment schedule.
- Choose the HELOC if: You need flexibility for ongoing or uncertain expenses, you want the option to draw funds over time, and you’re comfortable with a variable interest rate.
The equity in your home increases as you pay down your mortgage. It opens up the opportunity to use that equity to borrow and finance other expenses. Qualifications for home equity loans vary among lenders. In addition to having enough equity in your home, most lenders will also check your credit score, monthly income, and your debt-to-income ratio. Tap to learn more about Benchmark Federal Credit Union’s competitive rates on home equity loans and HELOCs. Ready to tap into your home’s equity? You can apply in person or online.
In some cases, depending on how you use the funds, interest paid on a home equity loan may be tax-deductible. Read our Benchmark blog, “Are Home Equity Loans Tax Deductible?”