With mortgage interest rates rising for the first time in a long time, it’s a good time for homeowners to consider the various ways they can borrow against their home equity for various needs.
Here’s how mortgages, home equity loans, and home equity lines of credit work, and the best reasons to use each type of loan.
A traditional mortgage is the loan that allows you to borrow the largest amount of money at the longest possible term with the lowest relative monthly payment.
But the upfront costs are higher than other borrowing options, and if you pay off the loan over the original intended term, you’ll likely pay more in interest than you would with a home equity loan or line of credit.
The majority of mortgages are for 30 years, but you may be able to get a lower rate for a 15 year mortgage. Usually there is little or no penalty for paying off the mortgage before it’s due, but check with the lender to be sure.
Borrowers can choose either a fixed- or adjustable-rate mortgage, but with rates near historic lows, it’s probably safer for long-term borrowers to choose the fixed-rate option (even if the initial rate on the adjustable option is a currently a little lower than the fixed-rate loan).
Costs $2,000 and up, and depending on the loan, the borrower, and the property, initial expenses can approach $10,000 or more.
Best for: Homeowners who want (or need) the most possible money from their home equity, and think that interest rates may rise in the future. Also good for those who are concerned that it may be difficult to get a mortgage in the future, due to changes in their own circumstances or economic conditions.
Home equity loans
A home equity loan is like a fixed-rate mortgage, but usually the amount of money borrowed is less and the term of the loan is shorter.
The initial costs of a home equity loan are less expensive than the closing costs of a traditional mortgage, but the interest rate is often a half-percent or so higher.
Costs $500 to $1,500
Best for: paying for an immediate, known cost (such as a larger home remodeling project or paying off high interest credit card debt), or when it’s the most attractive borrowing option for a shorter-term expense (like higher education expenses).
Home equity lines of credit
Once established, a home equity line of credit (HELOC) allows you to borrow against the equity you have established in your home, up to a pre-approved amount.
The interest rate is typically adjustable, but usually can only go up a certain amount within a particular time frame (such as two percentage points over a year), and may be capped at a particular rate (like 12%).
You only pay interest on what you borrow, when you borrow. After a period of time, the lender may request that you either repay the loan, or convert it to a new loan with a fixed interest rate, time period, and a monthly payment of principal and interest.
Costs Typically range from a few hundred dollars to over $1,000. There also may be a small annual fee ($50 to $100) to keep the HELOC open.
Best for: when you have no immediate need for the money, but would like to have the option to tap the HELOC to cover unexpected expenses or in an emergency. Hopefully you will be able to repay the borrowed amount within a couple of years.
Your next steps
If you’re in the market to get one of these loans, contact your local bank or credit union to see which options would be best suited for your needs, and what the costs of each would be.
Don’t hesitate to contact other lenders to compare their offerings to your current institution. You may save hundreds or thousands of dollars in fees and interest expenses, but make sure you read the fine print before you sign on the dotted line.