Homeowners can use the equity in their homes to pay for home improvement projects, college tuition, medical bills and other expenses. Equity is the calculated difference between the current market value of the residence and the principal balance owed on any loans secured by the property. Home Equity Loans and Home Equity Lines of Credit (HELOCs) are two forms of low-interest rate financing. They allow borrowers to access equity without selling their homes.
However, with recent Federal Reserve rate changes1 and additional ones forecasted, which borrowing option makes the most sense for your finances?
Here are four questions to ask when deciding between a HELOC and a Home Equity Loan.
Do you have a specific expense in mind?
If the answer is yes, consider a Home Equity Loan instead of a Home Equity Line of Credit. When you know the amount needed before applying for your equity loan, it’s possible to secure a fixed-rate loan with predictable monthly payments. Changes to the Fed rate won’t impact your Home Equity Loan. Financial institutions issue this type of equity loan in one lump sum. A set repayment amount and set term length are two of the most attractive features of Home Equity Loans.
If you’re planning a home remodel or other expense typically financed in stages, a HELOC may be the better option. With a HELOC, you only pay interest on the outstanding balance during your draw period.
Can my budget comfortably adjust to a changing monthly payment?
If the answer is yes, then the flexibility of a HELOC might be the better option when compared to a Home Equity Loan. A HELOC has a similar feature to a credit card in that eligible borrowers are approved up to a specific credit limit. Borrowers can use as little or as much of the available balance as needed as long as they do not exceed the credit limit threshold.
Another feature of a HELOC is that it is often assigned a variable interest rate. As the Fed rate changes, so does the interest rate assigned to the outstanding balance, which can influence your monthly payment. However, HELOCs have the added benefit of allowing borrowers to make interest-only payments based on the borrowed amount.
How is my credit health?
Your credit health can play a significant role in the interest rate assigned to your loan. The higher your credit score, the greater the likelihood of receiving a favorable interest rate. Before you apply for a Home Equity Loan or HELOC, review a copy of each of your credit history reports. Home equity lenders assess your creditworthiness based on the information contained in these reports. Visit annualcreditreport.com to request a free copy of your report from each of the major credit reporting bureaus.
Credit history reports include a summary page that highlights data harming your credit profile. Pay special attention to that section and follow the suggestions for improving your credit. If you notice any incorrect information on your report, follow the credit reporting bureau’s dispute policies to make the needed corrections.
More favorable interest rates are available to borrowers with high credit scores when compared to those with average credit scores. Starting with a lower interest rate can make inevitable Fed rate changes less disruptive to your finances.
Using a HELOC or Home Equity Loan can be a smart financial move for many homeowners looking to reduce costs and save money. However, it’s crucial to have a strategy or purpose before you borrow to ensure the funds will improve your financial situation. Without a plan or goal for the equity funds, borrowing against the equity in your home may add to an already strained household budget.
Benefit from increased home values on the Front Range and use your home equity to meet a financial need.
*Equal Housing Opportunity, approval is subject to credit, income, and collateral qualifications.