What is home equity? To keep it simple, the equity of your home is the value of how much you actually own. You may accrue quite a bit of equity by making on-time monthly payments for many years or by placing a large down payment – 20% or more, typically – at the onset of your initial mortgage. Once you have achieved enough equity (which will be decided by your lender’s terms and conditions), you may choose to borrow against it for any number of reasons.
There are three methods of accessing the equity of one’s home:
- Home equity lines of credit, otherwise known as HELOC
- Lump sum home equity loans in a form of private 2nd mortgages
- The refinancing of the home itself
Each option has its own pros and cons, so let’s dive in and discuss them in-depth.
A home equity line of credit grants homeowners access to their equity through a series of withdrawals. Essentially, this type of equity access is a second mortgage that functions much like a credit card. You only take out money as it’s needed and then repay the amount borrowed as well as a set amount of interest.
The Benefits of a HELOC
- Fund home improvement projects, which often require multiple purchases made over a span of time.
- Only use the equity available to you when you need it.
The Drawbacks of a HELOC
- The management of finances can be quite a bit trickier if you are awarded a HELOC rather than a lump sum payment.
- If you are unable to pay your HELOC monthly payments, your home can be foreclosed on as a form of repayment to the lender.
Lump Sum Home Equity Loans
Unlike a HELOC, a lump sum home equity loan grants you access to a determined amount all at once.
The Benefits of a Lump Sum Loan
- Repayments are easily manageable on a monthly basis.
- These loans typically have lower interest rates than many types of high-interest credit cards.
- The requirements for this type of loan are often less than the requirements of a first mortgage.
- You can pay large, single-time expenses easily and quickly.
The Drawbacks of a Lump Sum Loan
- Payments must be made monthly, including principal and interest.
- Just like with a HELOC, your home faces the very real risk of disclosure if you cannot pay promptly each month.
- You are required to repay the cost of closing costs.
Refinancing Your Mortgage
Through refinancing, homeowners and lenders can redefine the terms of their mortgage loan. This entails taking out a new loan of the remaining value of the mortgage, wherein new terms and interest rates will be applied.
The Benefits of Refinancing
- Homeowners often end up with a lower interest rate than when they started.
- You gain access to the accrued equity of your home.
The Drawbacks of Refinancing
- There are associated closing costs that must be paid.
- Your lender may issue you a penalty fee for ending your pre-existing mortgage early.
Which One to Choose?
It all depends on your needs and what you are trying to make happen. If you are trying to consolidate high-interest credit card debt, for example, a lump sum equity loan is a great choice. If your aim is to renovate your home to resell at a higher price, a HELOC grants you that ability easily. When you want to renegotiate the terms of your mortgage while getting some cash in your hands, refinancing might be exactly what you need.
If you are ever unsure as to which method of equity access is right for you, confer with your lender or a mortgage attorney/broker to discuss your options.