Line of Credit Home Loan vs. Second Mortgage vs.
Home Improvement Loan: Which Is The Best Choice?
First, What Are These?
Home Equity Line of Credit (HELOC) - You take out a loan amount, but you don't have to take all of it at one time. Whatever you haven't yet taken, you don't pay interest on. Perfect for when you will not need all the money at one time.
Usually, you can't have a credit line of more than about 70% - 80% of your home's value. Don't forget to subtract what you owe on your first mortgage to get an idea of what you might be able to borrow. Remember you have to qualify for the payment on whatever amount you borrow. (Go to zillow.com and put in your address to get an idea of what your home might appraise for.)
Second Mortgage - Any mortgage that is not a first mortgage, or primary mortgage.
Home Improvement Loan - A second mortgage where you are using the money for home improvements.
Second, What Will Be Involved?
It will be quite similar to getting your first mortgage, except no seller or realtors or home inspection to deal with. Same paperwork, income and asset documentation, appraisal, title search, closing.
Third, Why Would You Get One?
Because your first mortgage has such a great interest rate that you don't want to lose it. The second mortgage or line of credit will have a higher interest rate (although the interest rate will be substantially lower than a lot of other borrowing options, such as borrowing from a credit card company).
Fourth, Should You Get One?
The upside is pretty clear: take money to pay for things you need from the equity of your home. Please pay for NEEDS (such a new roof insurance won't pay for), not WANTS (such as a fancier car) with the equity in your home. Your home equity is not a piggy bank to pay for outdoor kitchens, pools or other non-essential home upgrades. Remember such things may have little or no value to some potential purchasers of your home, while a roof that has been replaced in the last five years brings real value to the table.
If you use it for home improvements, research how much value the improvements will likely add to your home, take a number somewhere in the middle, and don't spend more than that. (Remember the high end of the range given will apply to very pricey areas only, and may not be applicable to your home.) Also consider: will it save you money over time in other areas, such as utilities?
I would always choose the "no interest if paid off on time" option if offered by a home improvement company. Zero interest is always the best.
Whether to use it for your children's education is something to really think about. Your home equity may be needed to help fund your retirement.
Fifth, What Can You Use It For?
Pretty much anything. But if you can't prove you used it for home improvements (or for purchasing a house), the interest is not tax deductible. Using it to pay off high-interest rate credit cards is questionable as to whether it makes sense, because you are causing that "loan" from your credit card company to take longer to pay off. Better to hunker down and pay extra on that credit card debt until it goes away.
Paying off a car loan with it: same thing. You probably just have a few years left on your car loan, and now you're extending it, maybe as long as 15 years. Does that make sense? Using the equity in your home to pay for your daughter's wedding? I can't get behind that idea.
Sixth, Who Should/Can You Get It From?
This is a loan that most smaller banks offer, and most major banks and mortgage companies as well. So you'll have lots of choices. If you don't plan to use all the money immediately, definitely get a LINE OF CREDIT because you only pay interest on any outstanding balance.
SHOP AROUND for interest rates and terms of the loan. Check for weird stuff, like a penalty if you pay the whole thing off early, or penalties for not using a certain amount of the money by a certain time. Also carefully think about an adjustable interest rate that might go up at a time when you can't afford it.
If paying only the interest (not the actual loan) is an option, DON'T DO IT! You will surely live to regret that decision. You can always pay on the loan itself even if you're not required to.
Last, This Is A BIG Decision.
Think about when you may sell your house and whether making significantly less money when you sell is going to be a problem for you. Money decisions must always be made looking at the big, long-term picture, not just today's needs.
An equity loan or line may make sense for you, but don't rush to do it. You are creating a possible risk of losing your home if the rate goes up and you have trouble paying it. OR the value of your home could decline and you could experience the unpleasant situation of being "under water", which is owing more on your house than it is worth.
An equity loan or line needs careful thought and planning.
If you applied for an equity loan or line and were denied due to your credit, click here.
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