Why Use a HELOC Instead of a Second Mortgage?
The average homeowner has two borrowing options if they want to access their home equity: home equity lines of credit (HELOCs) or a home equity loan. Although both are often referred to as “second mortgages,” they’re far from being interchangeable options.
A home equity loan is most similar to traditional mortgages. You’re borrowing a lump sum of money from the bank and will need to pay it back with interest over the course of a set term. Home equity lines of credit are markedly different.
Why Are Home Equity Loans So Important?
If you’re like the average New Orleans family, your house is very likely your most valuable asset. Even if you still have quite a bit left on your mortgage, the equity you’ve built may already dwarf the savings you have in your savings accounts or checking accounts. Unfortunately, that equity is also extremely illiquid. You would need to sell your home to access your home equity without a second mortgage, which also means you would need to:
- List your home, deal with real estate agents and home shoppers and pay all the related fees
- Go through the whole mortgage application process again if you plan on buying another house (likely a downgrade since you need to get cash from your existing equity)
- Go back to renting if your budget or the housing market prevents you from buying another home that meets your needs
- Move your family to a new home (maybe a new school district and community as well)
Homeowners don’t need to be told about the downsides of buying and selling a home because they’ve been through it before – but those disadvantages are particularly relevant for understanding the benefits of home equity loans. Both HELOCs and traditional second mortgages allow homeowners to avoid those pitfalls and still easily access their home’s equity.
Scenarios in Which a HELOC Is Preferable to a Home Equity Loan
The option that’s best for you will be highly dependent on what you need the money for. If you want to consolidate credit card debt, a traditional home equity loan may be the better option. Your existing credit card debt is quantifiable, so you know exactly how much you’ll need to borrow to consolidate it.
Other scenarios may be significantly more fluid – like if you want to renovate your home or add an addition. You may have a general idea of what you want to do but the costs of your project might go up or down over time. If you get a traditional lump-sum home equity loan you’ll be forced to pay interest on the entire amount, even if you end up changing your mind and only need half of what you borrowed.
With a HELOC, you only pay interest on the funds you draw. If you’re approved for $100,000 but only end up reroofing your home instead of building an addition, you might ultimately only spend $15,000. The flexibility of a HELOC makes it easy to change your plans and prevents you from paying unnecessary interest just because your plans changed.
Other examples include things like paying for college, starting a business or planning a vacation. While you might have a general cost target in mind for those things, the actual expenses might change dramatically over the five to 10-year HELOC draw period.
HELOCs can also be ideal for emergency funds. You might have read financial experts recommend having three to six months’ worth of living expenses saved up at all times just in case an emergency occurs. For many families, including many homeowners, that kind of rainy-day fund simply isn’t feasible. Having a HELOC available can be a great alternative safety net.
Ability to Pay Back and Restore Your Limit
In some respects, a HELOC is like a cross between a checking account and a credit card. You’ll be approved for a specific limit, but you can keep the line of credit open and never hit your limit during the draw period by paying back some of the funds while you go. For example, if you’re approved for $50,000, spend $30,000 and pay back $10,000 (50 – 30 + 10) – you could still borrow another $30,000. If you stopped there you would only pay interest on the $20,000 you borrowed – not the full $50,000 you were approved to borrow.
Access Your Home Equity Without Being Forced to Sell
It can be frustrating to know exactly how much equity you’ve built up in your home yet have no way to make use of it. HELOCs give you the ability to access those dollars but without some of the drawbacks and inflexibility of a traditional home equity loan second mortgage.
The mortgage team at OnPath Federal Credit Union makes it easy for our members to open HELOCs starting as low as $45,000. Contact our lending professionals by calling 504.648.2064. If you’re a resident of the greater New Orleans area but aren’t an OnPath member, we encourage you to learn more about the benefits of joining our credit union family.