When you are looking to refinance your mortgage, you may be considering between a home equity refinance or a home equity line of credit (HELOC) refinance. Both offer pros and cons but ultimately, you will need to understand them both in detail to create a refi plan that fits your needs. This article can help with that, but your loan officer can give you more personalized guidance.
What is a home equity loan?
Home equity is the true value of your home minus the amount you still owe. This loan allows you to borrow against the amount of equity in your home. This will entail a fixed monthly payment and interest rate. Home equity loans are funded in a lump sum that is paid back over the course of 5-30 years. Your monthly payment will remain the same because of the fixed interest rate these loans come with.
What is a home equity line of credit (HELOC)?
You can think of this like a credit card, but with a variable APR. With this option, you can borrow a portion of your home equity. You will repay this over time gradually. It is important to indicate that there is a draw period that comes with HELOC’s. This means that there is a specific period where you have access to the cash; typically, 10 years. In this period, interest-only payments will be the only thing you have to pay back. This is followed by a 10-20-year repayment period. During this time, borrowing is ceased, and principal/interest payments are required to be paid. This option is good for those who have long-term financial needs or are simply unsure how much money they need.
What are the main differences?
- Average APR: even with the fluctuation of the market, a HELOC will generally have a lower interest rate.
- Fixed Variable Rates: While HELOCs come with variable rates, home equity loans come with a fixed rate.
- Repayment Period: If you decide on a home equity loan, your payments will begin right away. If you choose and HELOC, you only must pay interest for the first 5-10 years. After that, you will spend the last 10-20 years paying back principal/interest together.
- Disbursement of Funds: If you require the full amount of your loan upfront, a home equity loan is the way to go. But, with a HELOC you may only take out as much as you need on an “as needed” basis.
Home Equity Loan for Debt Consolidation
It is very possible to use a home equity loan for debt consolidation. If you choose to do this, make sure you are making the best strategic decision for you. Look at the benefits and downsides of using a home equity loan for debt consolidation.
- Lower Rate: It is likely that you may be able to get a lower interest rate in comparison to other loans. This is because a home equity loan is secured.
- Single Streamlined Payment: You will have one payment throughout the month. This is much easier than multiple payments per month to worry about.
- Lower Monthly Payments: This is a direct effect of a lower rate. With a lower rate, your total loan payment, over the life of the loan, may equate to less than all your existing debt payments combined.
- Debt Load: There is a possibility of increasing our debt load. This loan may be able to consolidate your debt, but only if you limit the spending that initially caused your debt to become overwhelming. It is just like racking up credit card debt then continuing to purchase things on that credit card.
- Collateral: The fact is: your home is collateral. Your home is what secures the loan. That being said, paying your monthly amount, on time, is imperative. Missing payments can lead you on a path to foreclosure. If you feel that you cannot make payments, it would be a good idea to investigate other debt consolidation options.
- Fees and Charges: It is possible you may be faced with more fees and charges than you thought. A home equity loan is looked at as a second mortgage, so this means closing costs. This loan uses the up-to-date value of your home. If your appraisal is outdated, you may need to have some extra cash for a new one.
Requirements for A Home Equity Loan
- 650 or Higher Credit Score: The higher the score, the lower the rates. You want the best rate possible, so make sure your credit is in good shape.
- 15-20 Percent Home Equity: The amount of equity you have in your home is your golden ticket; considering it determines the amount you can borrow.
- Debt-to-Income Ratio: 43% or lower is what you are going to want to shoot for. You want to stand out as a low-risk borrower.
- Consistent Payment History: A good way to make sure you get approved is by keeping records of on-time bill payments. This will show the lender that you have a solid pattern of on-time payment, therefore, increasing your approval chances.
- Adequate Income: Mortgage companies want to make sure you will be able to repay the loan; they will look closely at your income. Higher-income also means a more favorable debt-to-income ratio.
When to Consider a HELOC
Those looking for some flexibility when borrowing often consider a HELOC. You cannot turn a blind eye to the risk of possibly losing your home. You need to make sure you are fully capable of making payments. There are many popular reasons homeowners consider a HELOC.
- College Tuition: In this case, a HELOC makes sense as opposed to another loan. Some HELOCs can provide lower interest rates than most student loans.
- Home Improvement: If you are thinking about taking part in some home improvement, this loan may be the best thing for you if the project will increase the value of your home.
- Medical Bills: If you have serious ongoing medical expenses, a HELOC can save you and provide a lower interest rate.
- “Bank Breaking” Purchases: With a longer repayment period, you may want to consider a HELOC for a large purchase. Plan properly to make consistent, on-time payments.
With rates so low, refinancing to a lower rate and pulling out some equity to pay off higher-interest debt might be a great option for you. It all depends on your current situation, but at the very least you should speak with a professional mortgage advisor to see if you could benefit from a debt consolidation refinance.