When Should You Take Out a Home Equity Loan or Line of Credit?

No homeowner wants to borrow more money. However, if you’re experiencing hard financial times or looking for a way to fund a home improvement project, there are ways to borrow money with your home as collateral.

In this article, we’re going to talk about home equity loans and home equity lines of credit (HELOC). We’ll explain how they differ and break down their benefits and risks.

Before the bubble

Before the financial crisis of 2007-2008, many homeowners were borrowing readily based on the equity of their home. Interest rates were low on home equity loans, encouraging homeowners to leverage their portion of homeownership.

During the recession, however, all of that changed. People owed more money on their mortgages than their homes were worth, and banks became reluctant to lend.

In recent, years, however, house prices have been creeping back up, and banks and homeowners alike have gained confidence in the equity of their home.

As a result, a growing number of homeowners are turning back to home equity loans and lines of credit as a source of low-interest financing.

So, what exactly are these loans and credit lines?

The difference between a home equity loan and a line of credit

A home equity loan is a lump sum of money that you borrow which is secured by the value of your home. Typically, home equity loans are borrowed at a fixed rate. Lenders take into consideration the amount of equity you have in your home, your credit history, and your verifiable income.

A home equity line of credit (HELOC) is a bit different. Like a credit card, you are able to borrow money as you need it via a credit card or checks. HELOCs often have variable interest rates, which means even if you’re approved for an initial low rate it could be increased. As a result, HELOCs are better suited for borrowers who can withstand a higher leverage of risk and variation each month.

Is now a good time to borrow?

If you’re a homeowner, there’s an understandable temptation to use the equity you’ve built over the years to your advantage. In some cases, home equity loans and HELOCs can earn you better interest rates than other forms of borrowing.

However, as with other loan types, it’s important for homeowners to realize that HELOCs and home equity loans are not the same as having cash in your savings account.

Another danger that borrowers face is the potential for foreclosure if things go badly. While most lenders won’t seek foreclosure after a few missed payments, your home has been put up as collateral for repaying the loan. Most lenders will choose to sell a defaulted loan to a collections company rather than seek foreclosure.

Ultimately, the best course of action is to avoid borrowing unless it will help you out financially in the long term. However, for those with high home equity who may, for one reason or another, need to borrow, a home equity loan or line of credit might be the best choice.