If you’re thinking about home improvements loans, you may wonder if a home equity line of credit (HELOC) is a good choice—or if it might be better to get a personal loan instead. Each option has its own set of pros and cons, so you need to evaluate them carefully to see which one is right for you.
How does a HELOC work?
A HELOC, a type of second mortgage, is a revolving line of credit. It allows you to borrow against your home’s equity, which is your home’s current market value minus the amount you still owe on your mortgage. Depending on the lender and your creditworthiness, your borrowing limit could be as high as 80% of your equity. With a HELOC, you can borrow as much or as little of it as you need—much like a credit card.
The HELOC is divided into two periods.
- During the draw period, which is generally from 5 to 10 years, you can withdraw funds as you need them. You’ll pay interest only on the amount you borrow, which typically comes with a lower interest rate than an unsecured loan. If you repay the money you borrow, you can re-borrow it during this period.
- During the repayment period, which is typically from 10 to 20 years, you need to pay back both the interest and the principal.
There are two types of HELOCs. The most common is the traditional, variable-rate HELOC, in which the interest rate fluctuates based on market conditions. There is also a fixed-rate HELOC, in which you’ll have the same interest rate throughout the repayment period (and perhaps also the draw period, depending on the HELOC). It’s possible to borrow some funds at a variable rate and some at a fixed rate.
Other HELOC costs can include closing costs, annual fees, and inactivity fees. On the other hand, the interest you pay might be tax deductible if you use the money for home improvements.
What is the benefit of obtaining a personal loan instead of a HELOC?
Instead of asking for collateral for a personal loan, the lender evaluates your credit score, income, employment history, and financial health to decide if you are eligible for the loan and what your interest rate will be.
Unlike a HELOC, if you default on a personal loan, your home is not at risk of foreclosure. Also, if your home drops in value, you don’t need to worry about owing more on your home than it’s worth.
With a personal loan, you need to determine ahead of time the amount you want to borrow, and you’ll receive it in a lump sum. This keeps you from the temptation to overborrow and get into more debt than you wish—which is a real possibility with a HELOC if you are not careful.
You may receive your personal loan within a few days of applying, while the HELOC process can take weeks and may require a home appraisal.
Most personal loans come with a fixed interest rate, which means predictable monthly payments throughout the loan term. Once your loan is approved, you typically have 2 to 7 years to pay it back, depending on the lender and the terms.
Possible costs to keep in mind include an origination fee, which is a one-time charge for processing the loan, and a pre-payment penalty if you pay off the loan early.
Which is right for you?
Both a HELOC and a personal loan have advantages and disadvantages. Consider these questions:
- Are you comfortable having a second lien (mortgage) on your home?
- How much money do you need?
- Do you prefer a fixed rate or a variable interest rate?
- What is your current financial situation and credit standing?
- Do you have a budget in place to determine how much you can afford to borrow and pay back?
- What will be the impact on your credit score?
Take the time to carefully consider your options for home improvement loans, so you can make an informed choice! Whether you’re replacing your roof, remodeling your kitchen, or expanding your living space, keep in mind that borrowing money is best for projects that add to your home’s value. Contact Coast Central today to get started and make your home improvement dreams a reality!