Using the equity in your home to pay off unsecured debt or make home improvements can be a difficult financial decision. Low annual percentage rates, tax-deductible interest, and streamlining your monthly payment make second mortgages extremely attractive. However, using your home for collateral is a decision that should be weighed carefully. This blog will cover home equity loans vs. HELOCs and provide information that can help you decide which is right for you.
Home equity loan or home equity line of credit (HELOC)?
Second mortgages come in two basic forms: home equity loans and home equity lines of credit (HELOC). They typically offer higher interest rates than primary mortgages because the lender assumes greater risk – in the event of foreclosure, the primary mortgage will be repaid before any seconds. However, because the loan is still collateralized, interest rates for second mortgages are usually much lower than typical unsecured debt, like credit cards and consolidation loans.
The other major advantage of second mortgages is that at least some of the interest is tax deductible for borrowers who itemize. To receive the full tax benefit, the total debt on your home, including the home equity loan, cannot exceed the home’s market value. Check with your tax advisor for details and eligibility.
Is a second mortgage a good idea?
Before deciding which type of second mortgage is best for you, determine if you really need one. If you have ongoing spending issues, using the equity in your home may not help and can hurt. Ask yourself the following:
- Do you frequently use credit cards to pay for household bills?
- If you subtract your expenses from your income, is there a deficit?
- If you were to pay off your creditors by using the equity in your home, would there be a strong possibility of incurring more unsecured debt?
If you responded “yes” to any of the preceding questions, tapping the equity in your home to pay off your debts may be a short-term solution that can put your home in jeopardy of foreclosure.
If you use the equity in your home to pay off your unsecured debts, then run up your credit cards again, you could find yourself in a very difficult situation: no home equity, high debt, and an inability to make payments on both your secured and unsecured financial commitments. Spending more than you make is never a good reason to use the equity in your home.
How do you get started?
Once you’ve determined that using home equity is sensible, your next step is to understand the process of obtaining a second mortgage and choosing between a home equity loan and a HELOC.
Here are some factors to consider.
One thing to consider when shopping for a second mortgage is closing costs, including loan points and application, origination, title search, appraisal, credit check, notary, and legal fees.
Another decision is whether you want a fixed or variable interest rate. If you choose a variable rate loan, find out how much the interest rate can change over the life of the loan and if there is a cap that will prevent the rate from exceeding a certain amount.
What’s the APR?
Shopping around for the lowest APR (annual percentage rate) is integral to getting the most out of your loan. Home equity loans and HELOCs calculate the APR differently, complicating a side-by-side comparison. The APR includes points and other finance charges for traditional home equity loans, while the APR for a HELOC is based solely on the periodic interest rate.
Other factors to consider.
Before you make any decision, contact multiple lenders to compare the APR, closing costs, loan terms, and monthly payments. Also inquire about balloon payments, prepayment penalties, punitive interest rates in the event of default, and inclusion of credit insurance.
When shopping for loans, do your homework – ask fellow workers, neighbors, and family members for dependable leads, and research the Internet for immediately accessible quotes. Check in with established neighborhood banks and credit unions.
Home equity loans.
With a home equity loan, you will receive the cash in a lump sum when you close the loan. The repayment term is usually a fixed period, typically five to 20 years. Typically, the payment schedule calls for equal payments that will pay off the entire loan within that time.
Most lenders allow you to borrow up to the equity you have in your home – the house’s estimated value minus the amount you still owe. You are not required to borrow the full amount, but can instead borrow only what you need.
Interest rates are usually fixed rather than variable. You might consider a home equity loan rather than a HELOC if you need a set amount for a specific purpose, such as home improvements, education, or medical expenses, or to pay off your entire unsecured debt. And with a fixed rate, you have the certainty of knowing what your payment will be throughout the life of the loan, making it easier to budget.
HELOC.
A HELOC is a form of revolving credit. A specific amount of credit is set by taking a percentage of the appraised value of your home and subtracting the balance owed on the existing mortgage. Income, debts, other financial obligations, and credit history also determine the credit line.
Once approved, you can borrow up to that limit, in restricted increments. Some lenders will charge membership or maintenance and transaction fees every time you draw on the line.
Interest is usually variable rather than fixed. However, the repayment term is usually fixed, and when the term ends, you may be faced with a balloon payment – the whole unpaid portion of your loan.
The advantage of a HELOC is that you can take out relatively small sums periodically, and interest will only be charged when you withdraw the money. The disadvantage is the temptation to charge indiscriminately. Another plus is that the interest on a HELOC is typically less than that of credit cards.
Watch out for too-good-to-be-true offers.
You may be tempted by offers that allow you to borrow up to 120% of your home’s equity. Be aware that interest above the home’s equity limit is not tax deductible. Additionally, you won’t be able to sell your home until the lien is satisfied, which can negatively impact the marketability of your home.
Final thoughts.
Here’s one more piece of information to keep in mind when considering either of these products, if you suddenly change your mind, federal law gives you three days after signing a home equity loan contract or HELOC to cancel the deal for any reason. As always, read the full contract before signing any loan paperwork.
When shopping for your loan, consider us. We have affordable home equity loans and HELOC rates and terms! Here are the basics:
| FIGFCU | Fixed Rate Home Equity Loan | Home Equity Line of Credit (HELOC) |
| Percentage of home equity that can be borrowed | 100% of your home’s equity | 100% of your home’s equity |
| Amount that can be borrowed | Up to $750,000 | Up to $750,000 |
| APR | Rates as low as 6.99%* when you have Direct Deposit and Auto Pay | Rates as low as 7.49%* when you have Direct Deposit and Auto Pay |
| Fixed or variable | Fixed | Variable |
| Term of loan | Up to 240 months | Ongoing |
| Available in all states except for | AL, AK, FL, HI, and LA | AL, AK, FL, HI, and LA |
| Prepayment penalty | None | None |
Remember, we’re not-for-profit and Member-owned, so not only can we typically offer better rates than banks and other financial institutions, but we also offer candid advice to help you make a decision that works for your financial situation. To learn more or apply for a fixed-rate home equity loan or HELOC, click here. Not sure which is right for you, call us at 800.877.2345.
*APR = Annual Percentage Rate. APR is the annual rate of interest that is paid on an investment, without taking into account the compounding interest within that year. Rates are subject to change at any time.
1.00% rate discount is for a minimum of $1,000 monthly ACH Direct Deposit or Agent Net Check into a Farmers Insurance Federal Credit Union Checking Account and Automatic Payment/Folio Deduction as a repayment method to qualify. Rates are subject to change at any time.
There is a $500 refinance fee for Home Equity Loans booked within the last 12 months, unless $20,000 new cash is added to the loan request.
