A major benefit of home ownership is the ability to tap into your equity and borrow money at an affordable rate. You get a much lower interest rate on a loan with your home as collateral than you do on an unsecured personal loan. The challenge is to compare the advantages of a home equity loan and a home equity line of credit (HELOC) so you pick the right financing option.
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Home Equity Loan Advantages
Predictable Monthly Installments
An equity loan is paid with a single lump sum. You repay the loan with fixed monthly payments on an amortized schedule, just as you do your original mortgage. This predictable repayment makes it easier to budget the added amount for each installment. You know what you owe each month for the 10 or 15 year term.
No Interest Hike Risks
The initial interest rate on an equity loan is often higher than a comparable line of credit. However, the equity loan more has a fixed rate, whereas the line may have a variable rate. With a loan, you do not have to worry about rising interest rates. Your rate on a variable HELOC could rise over time.
Flexibility for Unpredictable Expenses
A HELOC is a great fit if you do not know how much you need to borrow. When you start a new business, it is hard to forecast all expenses involved. Therefore, a credit line makes more sense. You borrow what you need when you need it, up to a limit, which protects against taking on more debt than is necessary.
The credit line has a couple payment flexibility benefits as well. You only owe interest as you borrow the money with a HELOC, whereas you pay on the entire balance with a loan.
Plus, HELOCs offer an interest-only option during the initial draw period where you have access to borrow. Paying just the interest amount does not lower your principal balance, but it keeps your payments low until you get into a better financial position that allows you to pay more.
With each of these loan types, you get a low interest rate and a potential tax break. The equity loan works well if you know the exact amount you need and prefer constant payments at a fixed rate. The HELOC is the better choice when you need borrowing flexibility and prefer to pay only interest at first.