As a homeowner in Northwest Arkansas or Southwest Missouri, you have plenty of options available to you when it comes to taking out a personal loan. Borrowing against the equity of your home through a home equity loan or home equity line of credit means that you can get access to the funds you need quickly.
Both home equity loans and HELOCs typically have lower interest rates than a traditional personal loan. But which option is right for you? We’ll walk you through the difference between the two so that you can make a decision that works for your financial situation.
What Is a Home Equity Loan?
A home equity loan is similar to a conventional mortgage, in that it’s a fixed-term loan that you apply for through a lender.
The amount you’re able to borrow is based on the equity that you have built up in your property and you take out the loan for the full amount as a lump sum. In most cases, you’ll be able to take out up to 80% of your total equity in your home’s value.
Like a second mortgage, your home equity loan has a fixed interest rate over the lifetime of the loan and you’ll pay a fixed amount each month to repay it.
Knowing how much your loan repayment is going to be each month can make it much easier to budget and account for these extra costs.
Since the loan is based on your equity in your property, that also means that your home serves as collateral should you fail to make repayments. It’s also important to know that, if your property value decreases over the course of your loan, you could find yourself paying back more than your home is actually worth.
Much like with the mortgage you used to purchase your home, a home equity loan also comes with closing costs that you’ll need to factor into your budget.
Appraisal fees can be around $300-400, while credit reports, origination fees, title searches, and document preparation can all add another $250 or more to the total. However, once that amount is paid during the loan approval process, you won’t have to pay any additional fees for maintaining the loan.
How To Qualify For a Home Equity Loan
To qualify for a home equity loan, your lender will look at several areas of your financial history in order to make their decision.
First, the amount of equity that you currently have in your home is assessed. For many lenders, they’re looking to see that at least 15-20% of your home’s total value has been paid off with an existing mortgage. During this part of the process, you’ll also need to go through an appraisal to look at the current housing market in your area.
Lenders will also take a look at your credit history and debt-to-income ratio to see how much you can afford to pay back each month throughout the lifetime of your loan. Try to keep your overall debt below 40% of your total income each month.
Is a Home Equity Loan Tax Deductible?
You may already know that your mortgage interest is tax deductible, and any home equity loan that you take out will likely follow the same rules come tax season. There are some limitations, though.
Single filers can deduct the interest on their home equity loans totaling up to $375,000, while joint filers can do so on loans up to $750,000 – this can be in a single home equity loan or multiple loans that add up to these amounts.
You can also only deduct the loan interest if you’re planning to use your funds for home improvements, like building an extension or renovating part of your property. Interest on home equity loans used for personal living expenses, like paying off a credit card, are not tax deductible.
What Is a Home Equity Line of Credit?
Home equity lines of credit, or HELOCs, are similar to home equity loans in that the amount you’re able to borrow is based on the equity that you have in your home. But after that, things start to look a little different!
HELOCs are more like credit cards than traditional home loans, just without a physical card in your hand. You’ll be approved for a fixed credit limit for a specific amount of time (usually 10 years), where you can borrow any amount up to that total at any point. Once you’ve repaid those funds, they’ll be available for you to use again until the credit end date.
The most significant pro to a HELOC is that you’re only paying interest on the amount you borrow, not the whole amount that you’re approved for. This means that, as you take out money when you need it, no additional interest on those unused funds is being accrued.
While only paying interest on your withdrawn amount is a pro, the flip side is that your interest rate with a HELOC is going to be variable. You can help to manage this by only taking out funds at low interest periods. But if you need that money during a high interest period, you’ll be making higher repayments later on.
Much like a credit card, a revolving line of credit can also open the door to overspending if you give into temptation. It’s important to stay on top of how much you’ve borrowed and what you owe in repayments so that you’re not maxing out the equity in your home.
How To Apply For a Home Equity Line of Credit
When you’re thinking about how to get a home equity line of credit, it’s a very similar process to a home equity loan. A lender will want to know details about your home equity, debt-to-income ratio, and your credit history.
Depending on the size of your HELOC, your lender may look more closely at your credit history, particularly when it comes to repayments. This type of loan allows you to borrow from the same pot over and over again until a fixed date, so knowing that you have a good repayment history is crucial in the approval process.
Is a HELOC Tax Deductible?
Following the IRS’s rules that came into effect in 2017, interest payments made on home equity lines of credit also qualify for tax deductions. Like with a home equity loan, though, you’ll need to be using your funds for home improvements in order to qualify.
Choosing Between a Home Equity Loan and a HELOC
So home equity line of credit vs. home equity loan, which is the right one for you? It all comes down to how you would prefer to access your home equity loan funds and the way that your monthly payments are calculated.
To help you make a decision, here are a few examples of when each type of loan works best.
How Much Can You Borrow?
To know how much you might qualify for with either a home equity loan or HELOC, you need to know your home-to-value ratio, or LTV.
This is calculated by dividing your outstanding mortgage balance by the current market value of your home.
Most lenders will want to see this number lower than 80% – this means that the equity in your home is 20% or more. From here, you can decide whether a home equity loan or HELOC is best for you.
When you have outstanding expenses or you’re not sure how much you want to borrow, a HELOC is going to be a better choice. Variable costs that work well with HELOCs are:
- Ongoing home renovations or upgrades
- New appliances
- Short term debt consolidation
- Emergency funds
Since you can keep borrowing on that loan until the term ends, a HELOC is best for when you have ongoing financial needs that could change over time.
Home Equity Loan
If you know exactly how much you need to borrow, a home equity loan may be the right choice for your financial situation. Expenses that work better for these loans are:
- Fixed-cost home renovations
- Home additions
- Room remodels
- Long-term debt consolidation
- One time needs like college tuition or business startup costs
Apply For A Home Equity Loan or Line of Credit
When you’re looking for a home lender in Eureka Springs, Holiday Island, Berryville, Huntsville, Harrison AR, or Cassville MO, reach out to the team at CS Home Mortgage. Our full-service home mortgages and home equity loans are perfect for your next property renovation or for paying off existing debts. Apply today or contact us to talk to our lenders.