Deciding Between HELOCs vs. Second Mortgages vs. Equity Sharing Agreements
3 Types of Home Equity Loans: Pros and Cons
If you own a home and need cash, you might be able to tap into your home equity to get it. Three common options are available: a home equity loan (HELOC), a home equity line of credit (HELOC) or a cash-out refinance. Each option has its own pros and cons, so it’s important to evaluate your needs and choose the right option.
A home equity loan is a lump sum loan with a fixed interest rate. You repay the loan over a fixed term, just like your first mortgage. A home equity line of credit is a revolving credit line with a variable interest rate. You can draw on the line as you need it, up to the maximum loan amount, and you make interest-only payments on what you borrow. A cash-out refinance replaces your first mortgage with a new one and gives you cash out of the equity in your home.
All three options require that you have equity in your home. How much equity you need depends on the lender, but it will typically be at least 20%. If you don’t have enough equity, you can try to get a joint home equity loan with a family member or friend.
Considerations
When you’re considering a home equity loan or line of credit, there are several important considerations:
• How much money do you need? A home equity loan provides a lump sum that you can use all at once. A HELOC provides flexibility since you can borrow what you need as you need it.
• What are the interest rates and fees? Home equity loans have fixed interest rates, so your payments will stay the same for the life of the loan. HELOCs have variable interest rates, so your payments could increase or decrease as the interest rate changes. Both loans have closing costs, which can include an appraisal, application fees and origination fees.
• How long do you need the money? Home equity loans have shorter terms than first mortgages, typically ranging from 5 to 15 years. HELOCs usually have 10-year draw periods, during which you can borrow against the line of credit, followed by a repayment period.
• What are the tax implications? The interest on home equity loans and HELOCs is usually tax-deductible if you itemize your deductions. Cash-out refinances are not tax-deductible.
• What is your financial stability? Taking out a home equity loan or HELOC requires that you have equity in your home. If you don’t have enough equity or your income is unstable, you might not qualify for a loan. If you qualify for a loan, you might have to pay for private mortgage insurance (PMI) if your loan-to-value ratio is over 80%.
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