October 19th, 2019 11:58 AM by Jackie A. Graves, President
As a homeowner, you have probably heard that you can use the
equity that you’ve built up in your home, or the portion of the home that you
own outright, in order to finance some of life’s big expenses, like education
costs, medical debt or home renovations. You may not know how to actually
borrow against your home equity, though, so we’re here to help you figure that
out. Let’s take a look at home equity loans and home equity lines of credit,
how they work, and how you can use them to pay for the things you need.
Without refinancing your mortgage, there are two ways to borrow
against your home equity. You can either take out a home equity loan or a home
equity line of credit (HELOC). While they may sound similar, they function very
For example, a home equity loan is often referred to as a second
mortgage because they work in a similar manner. With this type of loan, you’re
given the money as one lump sum and then you make fixed monthly payments over
the life of the loan in order to repay what you borrowed.
equity line of credit (HELOC), on the other hand, works more like a
credit card. You’re given a line of credit that you can draw from, as needed,
for a certain number of years. This is known as your draw period. During your
draw period, you usually only have to pay interest on what you’ve borrowed.
After your draw period is over, you enter the repayment period, where you can
no longer borrow against your home and you have to start paying back both the
principal and the interest on what you owe.
Home equity and HELOC loans can give you much needed cash, but
how you spend it determines whether tapping into your home’s equity is worth
it. See our guide below for the 4 fundamentals of using your home’s equity.
Choosing between a home equity loan and a home equity line of
credit may seem complicated at first, but in reality, it comes down to two
distinct factors. You need to decide how you want to access your money and how
you’d like your payments to be structured.
With a home equity loan, like a mortgage, your money is
disbursed in one large lump sum. This makes it better suited to be used to pay
for one-time costs like paying off large bills or consolidating other forms of
debt. A HELOC, meanwhile, can be borrowed from as often as needed during your
draw period, making it a better choice for ongoing costs like paying tuition or
funding a renovation that happens in several different phases.
Then, there’s also repayment to consider. With a home equity
loan, your payments are fixed, meaning they stay the same each month. This
makes home equity loans a smart choice for those who need to make sure their
payments fit into their tight budget.
While there are also fixed-rate HELOCs, they are rare. You’re
more likely to find a HELOC that allows for interest-only payments during the
draw period and a repayment of both the principal and interest once your draw
period is over. Keep in mind that while this repayment structure keeps your
payments low at first, the payments will go up once you enter your repayment period.
Calculating your loan payments will depend on how much you
borrow, as well as the interest rate that you’ve been given. Remember, the
interest rate that you receive will depend on your credit score and the rate at
which banks can borrow money.
To calculate your monthly payment on a home equity loan, you
divide the amount that you borrowed and your interest rate by the number of
payments you’ll make during the life of the loan. Since your payments on a home
equity loan are fixed, you’ll pay the same amount every month.
For a home equity lines of credit, figuring out your payment is
a bit more difficult. During your initial draw period, you’ll multiply your
interest rate by the amount that you borrowed. Then, during your repayment
period, your calculations will look more like those of a home equity loan.
You’ll factor in what you’ve borrowed and your interest rate and divide that
into fixed monthly payments over the remainder of the loan term.
The truth is that doing the math on a home equity loan or a
HELOC can get complicated. Your best bet toward figuring out what your monthly
payments will be is to use a HELOC-specific
calculator, or better yet, have your lender work up the numbers for
you before you sign on the dotted line.
If you’re in a considerable amount of debt, another way to
leverage your home equity is to use it to consolidate your outstanding debts
and decrease your overall interest payments. This will not only help you
streamline your debt into one manageable monthly payment, but also help you
decrease the amount you pay in total, since less interest will accrue over
To do this, start by adding up your total monthly
debt payments. Be sure to include your debt from all sources,
including credit cards, medical bills and student loans. Once you know what
that total number is, take out a home equity loan in that amount. Use the lump
sum payment from your home equity loan to pay off all your debts from other
sources. Once those are paid off, all you have to worry about is a singular
monthly payment for your home equity loan.
The added bonus here is that a home equity loan is secured by
your home, it will likely have a much lower interest rate than other unsecured
forms of debt, especially credit cards and personal loans. This means that if
you choose to use a home equity loan to consolidate your debt, you’ll be paying
less overall. On the downside, the lender can take possession of your home if
you choose to stop making payments.
While it’s important to know how to use your home equity, it’s
also crucial to realize that borrowing against your home is a serious
undertaking. After all, when you take out a home equity loan or HELOC, you also
give the lender the right to foreclose on your home if you fall behind on your
obligation to repay. The roof over your head is on the line, so you need to
take things seriously.
With that in mind, it’s important to limit the use of the equity
in your home to things that are truly necessary. While it may be tempting to
use the money for less important expenses, like a vacation or a big purchase,
you would be better served by saving up and waiting until you have the money in
hand. At the end of the day, while the equity in your home is a valuable tool
to have at your disposal, it’s also not one to be taken lightly.
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