Did you know that paying on a mortgage can do more for you than simply reducing your level of debt? By generating more equity in your home (that is, “owning” more of it by virtue of paying down your mortgage balance), you can tap into your hard-earned ownership for financial advantages in the future. Two of the most common options are home equity loans and home equity lines of credit. In order to understand how they work and which one is right for you, you must first learn more about what these terms mean.
Differentiating Home Equity Loans and Home Equity Lines of Credit
A home equity loan is, as its name suggests, a type of loan that is based upon the equity that you have in your property. For example, if your home is worth $200,000 and you have paid $50,000 toward it, you have $50,000 in equity. A home equity loan allows you to borrow against your own equity; in other words, since your equity is valued at $50,000, you may be able to take out a loan against the money that you have already paid. You are expected to repay a home equity loan just like any other loan.
A home equity line of credit is similar, except that instead of receiving a loan that you must repay, your equity acts like a credit card; you can spend as little or as much of your account limit as you like, and then repay it to bring your balance back to zero. A home equity line of credit is often abbreviated as a HELOC.
Interest Rates Compared to Credit Cards
One of the primary advantages of home equity loans is that they offer a financial opportunity that comes at a much lower interest rate than many credit cards. And because this interest rate is fixed, you can feel confident in always knowing what the rate is and how much you will pay. This can make budgeting simpler and will not lead to any unexpected surprises.
Your home equity loan works just like any other loan and is repaid over a set number of years as agreed upon in your contract. However, be aware that your home equity loan must be paid off before you sell your house. You may be allowed to pay off your home equity loan early, but it is important to read the terms of your agreement to understand whether this is possible.
Lump Sum Payout
Another advantage of a home equity loan is that, like many types of loans, you receive the loan amount as a lump sum payment. This differs from, for example, credit cards and home equity lines of credit, in which you have an account limit. By receiving a lump sum as your payout, your home equity loan can help you to pay for large expenses that may not fit within the account limit or single-purchase limit of other types of financial vehicles like credit cards.
Tax Advantage of Home Equity Loans
An additional benefit of a home equity loan is that in some circumstances, you can actually enjoy a tax advantage for using this type of financial vehicle. If you specifically use your home equity loan to help you fund home renovation projects that increase the value of your property and keep it in good repair, you may be able to list your home equity loan on your tax forms each year.
The interest you pay on your home equity loan may be tax deductible if you use your loan for this purpose; this process exists in order to encourage homeowners to boost the habitability and appeal of their own properties over the long term. By claiming a loan interest deduction, you could reduce your tax bill or even increase your refund depending upon your specifical financial circumstances.
Trust the Mortgage and Home Finance Experts
Whether you are considering the pros and cons of a home equity loan versus a home equity line of credit or you are simply looking for more information about the financial impacts that come with owning a property, be sure that you have an expert on your side to answer your questions.
The professionals at Fairfax Mortgage Investments are always happy to help you understand your next best step and can help you to secure a mortgage, home equity loan or HELOC with terms that are favorable for your situation. Reach out to speak to an expert and learn more about the best options for you and how you can proceed toward your goals for home ownership and financial security.