Home Equity Loan or Home Equity Line of Credit – Which One of the Offers is Better

Posted by on Jan 9, 2015 in Business, Business Investment, Business Tips | Comments Off on Home Equity Loan or Home Equity Line of Credit – Which One of the Offers is Better

Having decided to cash out the equity in the home, many people find it rather difficult to choose between a home equity loan and a home equity line of credit. Purchase of home is one of the biggest investments. Most of the purchases are made possible only through mortgages. After purchasing the home, you might need funds for repairing. Since your savings if at all any, would have been spent in the process of the purchase home, you might think of going for a second mortgage.

What makes you go for a second mortgage?

For some of the consumers, second mortgage helps to meet the expenses related to the education of their wards, to spend for unexpected medical treatment, for consolidating high interest loans and so on. When you apply for second mortgage, it is your house that is going to be presented as collateral again. The claim of the second mortgage lender on the property now becomes subordinate to the claim of the original mortgage lender. The interest rate on second mortgage is always higher than that of the first mortgage. It becomes necessary to know about the types of second mortgages to make an appropriate choice.

Types of second mortgages

Home Equity Loans, shortly termed as HEL and Home Equity Lines of Credit, known as HELOC, are the two types of second mortgages. Which of the offers can be ideal for your needs depends on certain factors.

Home Equity

What is your requirement?

The purpose of the offer should be understood first. If you need huge funds immediately for some major expense such as consolidating the existing debts or purchasing a car, it is suggested that you go for home equity loans. If you need financial support for small recurring expenses like education, medical bills or for small home repairs or vehicle repairs, your choice can be Home Equity Line of Credit. According to your needs, you can submit application to either of the offers.

Consider the interest rates

The interest rate on Home Equity Loan is fixed and so the repayments are predictable. Even if the market rates rise, the agreed interest rate on the availed loan will not change. This is a beneficial factor for the borrowers. This is ideal for the people who get regular income and who can afford to meet the payments with ease. Home Equity line of Credit has interest rate that is variable. The interest on the amount being withdrawn is calculated according to annual percentage rate which is influenced by the Federal Funds Rate. The amount of payment depends on the prime lending rate which tends to fluctuate.

How do you repay the loans?

If you are approved for HEL, the loan amount is disbursed in lump sum. The borrower of the home equity loan is required to make payments covering the principal of the loan and the interest every month. The payments towards the interest are exempted from taxes. In the option of HELOC, the borrower is required to pay only the interest during the specified ‘interest only’ period on the amount that is being withdrawn from the approved loan amount. The working of HELOC is similar to a credit card functioning. The amount can be withdrawn when necessary.

Term of the loan should be considered

The term of the loan for a home equity loan ranges from 5 to 30 years. The monthly repayments cover a part of the principal and the interest on the loan. At the end of every month the interest amount on the balance principal is calculated. At the closing term of the loan, there will not be any dues since the loan is being settled in full. In HELOC, the funds can be obtained for around 10 years. At the end of the term, the balance amount is converted into a loan and the maturity period is specified as 15 or 30 years. Since the term of the loan is stretched increasing the overall cost of the loan, it is advisable that you consider Home Equity Loan a better option than HELOC.

The impact of second mortgages on credit history

As Home Equity Line of Credit functions like a revolving credit card, the negative impact of HELCO on the FICO score is inevitable. HEL can be considered for improving the credit report as the choice of HEL indicates the borrower’s ability to make payments regularly.