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What Is Home Equity? Choosing a Home Equity Loan or a HELOC

Couple working with a home equity advisor

If you need to borrow money, you've likely done some research on the types of loans available. You've probably found that taking out a personal loan or using a credit card comes with a fairly high interest rate. However, it's possible to borrow at a lower rate if you use your home equity as collateral. The two main options for borrowing against home equity are a home equity loan and a home equity line of credit (HELOC).

What Is Home Equity?

To calculate your home's equity, take what your house is worth and subtract what you owe on the mortgage of the house. For example, if the market value of your house is $300,000 and you still have $120,000 to go on your mortgage, your home equity is $180,000.

What Is a Home Equity Loan?

If you are able to take out a home equity loan, you are borrowing money with a one-time loan using your equity as collateral. You have a set number of years in which you're required to pay back your loan, and the interest rate stays the same throughout the time you're paying the loan off.

What Is a Home Equity Line of Credit?

A home equity loan is different from a HELOC, which allows you to repeatedly borrow against your home equity up to a certain limit — like a credit card that you can use again and again as long as you don't exceed the limit. The interest rate on a HELOC can change over time, or you may be able to lock in a fixed rate.

The Advantages of Home Equity Loans

After answering "What is home equity?" and deciding if you want to borrow against your home, the next thing to explore is whether to choose a home equity loan or a HELOC. A big advantage of a home equity loan is that you get a fixed interest rate for the entire term of the loan. The fixed rate combined with a set deadline to pay back the loan means that you always know exactly how much your payments will be. Another advantage is that if you have a lot of equity in your home, you can borrow a large amount. That's useful if you need a large loan and your credit card limits are significantly lower than the sum you're looking to borrow.

The Advantages of HELOCs

While a home equity loan is useful when you plan to borrow only once, it's not the most convenient option if you expect to borrow multiple times. A HELOC is a form of revolving credit, like a credit card. But since your home equity is serving as collateral, the interest rate is significantly lower than on a credit card or other unsecured revolving debts. If you want to have continual access to credit as you pay off the amount you initially borrowed, a HELOC is a better choice for you. Also, a HELOC may offer more flexible payment terms than a home equity loan, which comes with fixed payments. And you may have the convenience of withdrawing money in multiple ways, such as by check or a designated credit card.

The value you own in your home can allow you to take out a home equity loan or open a line of credit with a low interest rate. When you need to borrow a large amount, that can be a lifesaver! But as with all loans, you want to weigh the risks and benefits before you make your decision.

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