Issue 25Living Smart
Finding the Right Home Improvement Loan
With spring right around the corner, and (hopefully) better weather on the way, many of us may begin looking into doing some spring-cleaning. Others may be looking into making some home improvements. Whether you’re looking to make an addition to your home or re-model, it may cost a large amount of money. In those cases, finding the right home improvement loan is extremely important.
Many homeowners today have a first mortgage on their home. This is usually from when the homeowner(s) made a home purchase, and is a substantial lump sum. However, home equity loans function differently from mortgages. Home equity loans have a variety of uses, including remodeling, education, marriage, and even investing in a second property. Just like a mortgage, there are fixed home equity loans (HEL), as well as home equity lines of credit (HELOC).
In both cases, a Home Equity Loan is a loan that uses your property as collateral. You need to have equity in your home in order to take out this type of loan. For example, if your home is worth $350,000 and you have a $100,000 mortgage balance owed on your home, you have $250,000 worth of equity in your home. In essence, equity will be the value of your home that is free and clear of any obligation.
Depending on the financial institution and your financial situation, you may be able to find a fixed-rate home equity loan (HEL). With a HEL, you would take out the entire amount of the loan in one lump sum to complete your home improvements, and then make monthly payments. Another option however would be to take out a HELOC.
A home equity line of credit (HELOC), in most cases, is a much better option for homeowners to utilize.
There are many different needs for a substantial amount of money on a year-to-year basis, and a HELOC gives you flexibility to utilize it as needed. The rate on a HELOC may be fixed for a small promotional period, but they are usually variable rate loans. Other rules may apply as well, depending on the financial institution. Such rules involve closing costs, the initial draw amount, the minimum outstanding balance, the draw period and the repayment period.
While it may sound like a lot of hoops to jump through, it is much simpler to understand once it’s broken down:
- Closing cost consists of anything that you have to pay for the HELOC to be booked for you. These costs usually involve the processing of your loan, which includes title fees, flood certifications, appraisal fees, and general processing.
- The initial draw amount is any amount that the financial institution requires you to take out once you close on the HELOC.
- The minimum outstanding balance is an amount that the financial institution requires you to maintain. For example, an institution may require you to have a balance of $25,000 for the first year on the HELOC, but then you can pay it down afterwards.
- The draw period and repayment period are the most important timeframes of the HELOC. The draw period consists of the time where you can utilize the HELOC as you wish; you can make payments towards the HELOC as well as take out funds from the HELOC as needed. During the repayment period however, the line is closed you can ONLY make payments back to the HELOC.
In general, a HELOC functions the same as a credit card but with a much higher limit- you will have a certain line limit, and will have to make minimum payments each month.
The payments on a HELOC would be lower than a HEL since you will only be charged interest on your outstanding balance, and if you are only taking out a small amount at a time, this will save you money in the long run as opposed to taking HEL out.
So, which is better for you? That is up for you to decide – you can take everything out at once with a HEL and have a fixed-rate loan or have flexibility with a HELOC, at the cost of having a variable-rate loan. In the end, both types of loans can help with making the home improvements you dreamed of!