Home Equity Loans
Home equity loans and lines of credit are often both referred to as 2nd mortgages today. The language that surrounds home equity loans has gotten a little sloppy, which is not good because a home equity loan — traditional second, and a home equity line of credit are quite different programs with vastly different implications. Essentially, there are two different types of home equity loans: term, or closed-end loans, and lines of credit.
Closed-End Home Equity Loans
Both home equity loans and lines of credit have shorter loan terms than traditional first mortgages. While the average mortgage term is 30 years, home equity loans and lines of credit usually last between 5-20 years. A regular home equity loan, or 2nd mortgage, is a lump sum of money most often accompanied by a fixed interest rate to be paid back over a defined amount of time. For example, you take out a home equity loan to borrow $20,000 on a 15 year term at 7.5 percent; you pay 180 installments of $185.40 over that 15-year period to pay it back. With this kind of home equity loan you get the $20,000 you asked for and you cannot draw out more money.
Open Ended Credit Lines
A home equity line of credit (HELOC) works much differently. With a HELOC there's a draw period for the life of your loan that specifies a time bracket in which you can draw out money. The draw period and the amount of money that can be accessed are set by the lender. If you are going to continually draw money out of your home a HELOC is nice because as you pay down principle on the loan your credit line regenerates in tandem. Say you have a $20,000 equity line of credit. You borrow $12,000, but you pay back $8,000 towards the principle, you now have access to $16,000. Home equity lines have variable interest rates that move with short term interest rates set by the Fed; depending on how much money you have drawn out and the rate change your monthly payments will fluctuate.
What is better for me?
First, you need to think about what you need the money for and what kinds of budget constraints you might be facing in the future. Home equity loans are great for drawing upon equity in your home when a refinance cash out is not the best option, but there are so many different programs in the market you have to be careful to find the right one. In general, if you know the exact amount of money you need and don't care to have the option of continually drawing out money then a regular home equity loan — second mortgage will work best. Conversely, if you are going to need constant access to money then a home equity line of credit will be best. Remember, the trade off for that added flexibility is counterbalanced with variable interest rates that will make your monthly payment vary. With a traditional home equity loan, you do not get that flexibility and are rewarded with a fixed rate.
Home Equity Loan Rates — does it matter?
You might be thinking, well I like the sound of both types of home equity loans, but it would be nice to have that extra flexibility that comes with a HELOC. Are rates going to even be an issue in relation to my home equity line? The rates of home equity loans fluctuate daily just as all mortgage rates; the current rate on a $30,000 HELOC is hovering around 6.5 percent. They also rise in tandem with interest rates set by the Federal Reserve, which has raised rates 15 consecutive times since rates hit 40-year lows in 2004. Home equity rates are important, however, if you are serious about entering into a home equity loan you must examine any particular loan program in its entirety. Home equity loans and their rates and fees differ greatly from program to program so it pays to speak with several lenders and expose your self to a number of different programs.