Is a Home Equity Line of Credit (HELOC) Right for You?
If you're a homeowner, you may be considering a home equity line of credit (HELOC). But what is a HELOC? And how does it differ from a second mortgage or a reverse mortgage?
Let's take a closer look at HELOCs, second mortgages, and reverse mortgages to see which one might be right for you.
What Is a HELOC?
A home equity line of credit is a loan that uses your home's equity as collateral. Home equity is the difference between your home's appraised value and your current mortgage balance.
For example, let's say your home is worth $250,000 and you have a current mortgage balance of $100,000. This means you have $150,000 in home equity.
With a HELOC, you can borrow against this equity. The amount you can borrow, and the terms of the loan, will vary depending on the lender. But generally, you'll be able to borrow up to 85% of your home's value.
So, in our example, you could borrow up to $212,500 with a HELOC.
HELOCs typically have adjustable interest rates, which means the rate can go up or down over time. And, most HELOCs have a draw period, which is the time frame in which you can borrow against your equity.
At the end of the draw period, you'll enter the repayment period, during which you'll need to repay the loan plus interest. The repayment period is usually around 10-20 years.
What Is a Second Mortgage?
A second mortgage is also a loan that uses your home's equity as collateral. However, with a second mortgage, you'll get a lump sum of money when you close on the loan.
With a second mortgage, you'll have a fixed interest rate for the life of the loan. And, like a HELOC, you'll need to repay the loan plus interest during the repayment period, which is usually around 10-20 years.
What Is a Reverse Mortgage?
A reverse mortgage is a special type of loan that allows homeowners age 62 and older to tap into their home equity without having to make monthly loan payments. With a reverse mortgage, the loan amount is typically repaid when the borrower sells the home or dies.
Reverse mortgages typically have high fees and interest rates. And, because they don't require monthly payments, the loan amount can quickly add up. For these reasons, reverse mortgages are usually only suitable for homeowners who don't plan on selling their home or who need the money for other purposes (such as medical expenses).
Which Option Is Right for You?
Now that you know the basics of HELOCs, second mortgages, and reverse mortgages, let's take a look at some factors to consider when deciding which option is right for you.
First, think about why you need the money. If you need cash for a one-time expense (such as home repairs), a second mortgage may be the better option since you'll get a lump sum of money upfront. If you need ongoing access to cash (for example, to cover medical expenses), a HELOC may be more suited to your needs since you can borrow as much as you need, when you need it.
Second, consider your financial situation. If you're comfortable making monthly loan payments, then either a HELOC or a second mortgage could work for you. If you're not comfortable making monthly payments or if you don't have enough income to qualify for a monthly payment, then a reverse mortgage may be your best option. Keep in mind that with a reverse mortgage, the loan balance will grow over time since you're not making monthly payments to reduce the balance. This can be beneficial if you plan on selling your home in the future since you may get more money from the sale after the loan balance has grown. However, it's important to remember that if you don't sell your home and the loan balance grows too large, you may end up owing more money than your home is worth. So be sure to consider this before taking out a reverse mortgage.