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By Jamie Smith
With home values on the rise in many parts of the country, some homeowners suddenly find themselves with increased equity in their homes. If you find yourself in need of money to pay off bills or start a home-improvement project, you may be able to use some of that equity. This option may be preferable over taking out a personal loan with high interest rates or selling your home. Here is a look at some of the available options to get equity out of your home and ways you can use it.
A cash-out refinance is not necessarily taking out a second loan on your house. You would begin with a refinancing loan, but for a larger amount than you owe. The difference between the two is the amount you can take in cash. The downside of a cash-out refinance is that you will have less equity in your home, and some banks consider these risky. Also, you can expect that closing costs will be higher.
A home equity loan is one of the main ways to unlock your home equity. This loan is a second mortgage loan that you take out for a fixed dollar amount and repay over a set period. You might take out $100,000 that must be repaid in ten years. Once you take out a home equity loan, you can't go back and increase the amount you borrow. That would require taking out another loan.
While a home equity loan is similar to a regular mortgage loan, repayment interest is typically higher on a home equity loan. The reason for this is that the primary loan is the first to get paid if you default on your mortgage, and the bank forecloses on your home.
Another option is a home equity line of credit, typically called a HELOC. Choosing a home equity line of credit will allow you more flexibility over a home equity loan. It's similar to second mortgage but has a revolving balance. With a HELOC, you only borrow what you need and then pay it off. You can then borrow more money against your home equity again and pay off that balance. It's similar to having a credit card, but the interest rates are usually much lower than credit cards.
Your interest rate is usually variable, and your payment amount on a home equity line of credit will also vary. Your payments are based on how much you use versus the available loan amount. Depending on the lender you choose, you might receive a debit card or a checkbook to access the funds in your HELOC.
There are two types of HELOC options — one is a standard HELOC while the other is an interest-only one. With an interest-only HELOC, the maximum repayment term may be longer. For example, you have the choice to pay back only the interest and amount of principal you choose for the first ten years. An interest-only home equity line of credit is attractive to people who are self-employed or have variable income. It may also be a better option for someone who expects their earnings to grow significantly in the coming years.
Understandably, you might be slightly confused about the differences between a home equity loan and a HELOC. Both a home equity loan and a HELOC have better interest rates compared to a credit card or personal loan. While credit card debt can spiral out of control, there can be added risk with a HELOC. Because your house is used as collateral for the loan, you risk losing your home if you default on the payments.
With a home equity loan, you receive a lump sum and repay that amount through fixed payments over the loan's term. Even if you don't need the entire home equity loan amount, your payments are set based on that loan as a whole. Home equity loans also have fixed interest rates. HELOC interest rates are typically variable. You can borrow only the amount you need up to your specified credit limit. The bonus with a variable interest rate on a HELOC — it could decrease as your credit improves throughout the loan period.
Both a home equity loan and HELOC rely on your home's equity, which is why they're known as secured debt. That's one major difference between a HELOC and a credit card. If you don't pay your credit card, the company will likely come after you for the default amount in court because it's unsecured. If you don't pay a home equity loan or HELOC, you risk losing your home.
A home equity line of credit has two parts. The first period is known as your draw period. It can last years, possibly even ten years. Once the draw period ends, you can't borrow more money. The second period is your repayment period which will last longer. If your draw period is ten years, your maximum repayment period might be 20 years. That makes your HELOC a 30-year loan.
You're still making payments during your draw period, but the amount varies. If you choose an interest-only HELOC, your payments during the draw period will be much smaller, as you're only paying interest. Once the repayment period starts, you have the added principle. Your payments will typically be significantly higher at this point, depending on how much you borrowed.
People's reasons for looking at a HELOC or other loan differ from family to family. Maybe you want to finally start your dream renovation project or make upgrades for a future sale. Some people opt to get equity out of their homes to purchase an investment property or vacation home elsewhere. If you're looking at property out of the country, financing a home or investment property is usually impossible. You can use your home's equity to gather the cash and purchase the property outright.
For other people, home equity offers them a chance to consolidate debt and pay off higher interest credit cards and personal loans. Unforeseen medical issues and long-term illnesses may also cause some homeowners to look into borrowing equity against their homes.
There's no right or wrong answer on what to use your home's equity for. As long as you meet the criteria and have high enough credit scores, it's your money. What's most important is to choose the right home equity option for you.
An Alliant HELOC could help you get the funds you need when you need it. Pay for a home renovation, vacation home and more.
Want to know more about a home equity line of credit? Check out these articles:
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