A lot of people, thanks to low interest rates, are thinking about home renovations right now. You have different options to pay for these projects if youre not going to pay in cash. One option is a Home Equity Line of Credit or HELOC.
A HELOC is a way to borrow against your homes equity, and it provides flexibility. With that being said, because of that flexibility, you need to be careful to stay on budget when you use funds.
The following are some things to know about a HELOC, particularly if youre thinking about using it for a renovation.
With a HELOC, youre spending in a way thats similar to a credit card. You borrow up to a certain limit as defined by your lender. Then, you pay back whatever you borrow with interest. You can withdraw and make payments on whatever basis works best for you.
A lender gives you a draw period, which is the time you can withdraw money. When your draw period is ended, you may be able to renew the credit line.
If you dont or cant renew, you pay the outstanding balance either all at one time, or you do so over a repayment period.
HELOC lengths can run as long as 30 years.
The benefits of a HELOC and flexible repayment include the fact that you only borrow what you need, and many have no fees. The interest on a HELOC might be deductible if you use your funds for home improvements.
While HELOCs can work well for funding a renovation, there are possible risks to be aware of before you borrow.
Since your home is your collateral, if you dont make the payments, you could lose your home. Typically a lender will try to protect against this by limiting borrowing amounts, but its still a big consideration.
A lender can also freeze a credit line or reduce it. Youll only see this usually if you havent made your payments or your homes equity changes, but its something to think about.
The interest rates on a HELOC are variable, and theyre tied to the prime rate. If there are changes in the market, you may end up paying more so that uncertainty may not be ideal.
A home equity loan is another financial product often used to fund renovations and home projects.
A home equity loan also involves borrowing against the equity in your home, which is used as collateral. A home equity loan differs from a HELOC because its a lump-sum loan rather than a revolving line of credit. You pay the loan back over its life plus interest, and you make those payments based on a set schedule. Most home equity loans have a fixed interest rate, which alleviates the worry of fluctuating market conditions impacting interest rates.
If youre deciding between a HELOC and a home equity loan, the loan might be better if youre certain of the cost of your project. If youre comfortable with a fixed monthly payment, a home equity loan could be the better option.
On the other hand, a HELOC might be right if you want a lot of flexibility in how much you borrow. Maybe youre not sure about the scope of your project or what your budget will be.
The biggest differentiators between the two will come down to first, flexibility, and second, certainty. If you want flexibility, consider a HELOC. If you want certainty, think about a home equity loan.
