Should you get a home equity loan or a home equity line of credit?

Ralph Estep Jr.:
00:00

Have you ever wondered whether a home equity loan or a home equity line of credit is the better choice for your specific financial needs? Well, stick around as we dive into this important topic. I'm going to help you make an informed decision.

Ralph Estep Jr.:
00:22

Imagine unlocking the value in your home to fund your dreams, pay off those debts, or invest in your future. But which key should you use: a home equity loan or a line of credit? Well, today we'll unravel this financial puzzle and we'll do it together. I'm your host, Ralph, and I'm here to help you achieve financial freedom while growing in your Christian faith.

Ralph Estep Jr.:
00:43

Now, before we jump in, let's take a quick look back at yesterday's show where we discussed biblical tithing and sacrificial giving. We explored how these practices can deepen our faith and impact our financial well-being. You'll find our catalogue of episodes at AskRalphPodcast.com. So check it out if you missed it.

Ralph Estep Jr.:
01:08

Now, let's hear from one of our listeners. This message comes to us from Gabby in Tulsa, Oklahoma. She writes this:

Ralph Estep Jr.:
01:15

"Dear Ralph, my husband and I are considering tapping into our home equity to fund some much-needed home renovations. We're torn between a home equity loan and a home equity line of credit. Can you help us understand the pros and cons of each option and guide us on which might be better for our situation? We're planning to spend about $50,000 on renovations. Thank you for your guidance."

Ralph Estep Jr.:
01:38

Well, thank you, Gabby, for your excellent question. I'm sure many of our listeners are in similar situations. So let's dive deep into this topic today. But before we do, I want to welcome all of our listeners, whether you're tuning in for the first time or you're a loyal follower. Thank you so much for joining me on this financial journey. Your trust and support mean the world to me.

Ralph Estep Jr.:
02:01

As we discuss home equity, let's keep in mind the words of Proverbs chapter 24, verses 3 and 4. It says this: "By wisdom a house is built, and through understanding it is established; through knowledge its rooms are filled with rare and beautiful treasures."

Ralph Estep Jr.:
02:18

I thought that was a great verse for today's topic. This verse reminds us that wisdom and understanding are crucial in managing our homes and finances.

Ralph Estep Jr.:
02:34

Now let's address Gabby's question about home equity loans versus home equity lines of credit, or what they call HELOCs. The truth is, both options allow you to borrow against the equity in your home, but they do work quite differently.

Ralph Estep Jr.:
02:45

So let's start with the home equity loans. Think of these as a second mortgage. You borrow a lump sum of money and repay it over a fixed term with a fixed interest rate. It's like getting a big check upfront. So, Gabby, here are the pros of these typical home equity loans:

Ralph Estep Jr.:
03:01

Number one, it's a fixed interest rate. Your rate won't change over the life of the loan, making budgeting easier. Number two, you have predictable payments. When you get the loan, you're going to know exactly how much you'll pay each and every month. Number three, you get a lump sum. It's ideal for large one-time expenses like Gabby's home renovation; she's already told us it's going to take $50,000 to do some renovations. And number four, you potentially could lower your interest rates compared to credit cards or personal loans. So Gabby, those are the pros.

Ralph Estep Jr.:
03:33

Now let's talk about the cons of home equity loans. First, they have less flexibility. You can't borrow more if you need it later. Secondly, you pay interest on the full amount. You pay interest on the entire loan from day one. And finally, you do have the risk of overborrowing. You might be tempted to borrow more than you need.

Ralph Estep Jr.:
03:54

Let's talk about Gabby's situation. She mentioned she needed $50,000. Well, maybe she goes to the bank and they say, "Hey, guess what, Gabby?" And I don't know her husband's name, but let's say Joe. So Gabby and Joe go to the bank and the bank says, "Hey, great news! You can actually borrow $100,000." So there might be an incentive to do that.

Ralph Estep Jr.:
04:11

Now let's look at HELOCs. So these are these home equity lines of credit. These work more like a credit card. You're approved for a certain amount, but you only borrow what you need when you need it.

Ralph Estep Jr.:
04:21

So Gabby, here are the pros of HELOCs: Number one, flexibility. You borrow only what you need when you need it.

Ralph Estep Jr.:
04:29

Number two, you pay interest only on what you use. You only pay interest on the amount you've actually borrowed. This is in contrast to the home equity loan, where you pay interest on the full balance even if those funds are sitting in your personal checking account.

Ralph Estep Jr.:
04:43

Number three could be potential interest-only payments during the draw period. Many have a draw period where you pay interest only, and then at some point, you'd lock into a more traditional home equity loan with a normal monthly payment stream. That's the HELOC we're talking about.

Ralph Estep Jr.:
04:58

And number four, it can be used for ongoing expenses or emergencies. A lot of people get these HELOCs as their backup plan or go-to if something happens. So those are the pros.

Ralph Estep Jr.:
05:09

But here's some cons of HELOCs. First of all, they do have variable interest rates. Your rate can change, potentially increasing your payments. This is especially an issue when we are seeing fluctuations in interest rates like we're seeing these days. You know, interest rates are very—what's the word I'm looking for?—they're very volatile.

Ralph Estep Jr.:
05:27

Secondly, you have the risk of overspending. The available credit might tempt you to spend more than planned. I've seen this with clients in my own practice. They used HELOCs and the projects didn't stop until they maxed out the loan. The truth is, many of these projects could have been done at a later time.

Ralph Estep Jr.:
05:43

And finally, you have the potential for payment shock. We talked about this a moment ago. When the draw period ends, payments can increase significantly. Or if the interest rates increase, it's going to go up. It's easy to get accustomed to that interest-only period during the draw period, and when the payment maxes out, it might just cause a bit of shock to your budget.

Ralph Estep Jr.:
06:01

So let's talk about the expected cost for each of these options. As with anything, there's going to be some costs. Both home equity loans and HELOCs typically have closing costs. That's the cost that goes into creating the loan and closing it. These can include appraisal fees, title search fees, and origination fees. You better budget from 2% to 5% of the loan amount for those fees. Now, for home equity loans, you might see interest rates around 5.5% to 7%. That's as of July 2024. On a $50,000 loan over 15 years, your monthly payment will be between $400 and $450. Now, HELOCs often have lower initial rates, maybe 4.5% to 6% as of July 2024.

Ralph Estep Jr.:
06:43

But remember, these rates can and do change. During the draw period, as discussed, you might only pay interest, which can be as low as $190 to $250 per month on a $50,000 balance.

Ralph Estep Jr.:
06:55

However, and this is a big "however," payments will increase when you enter the repayment period. So you might be asking, "Ralph, which option is better?" And I'm going to give you my standard answer: Well, it depends on your specific circumstances. For your situation, Gabby, where you're planning a one-time renovation with a known cost, a home equity loan might be the better choice for you.

Ralph Estep Jr.:
07:17

The fixed rate and predictable payments can make budgeting easier, and you won't be tempted to borrow more than you need. However, Gabby, if your renovation plans were less certain, if you didn't know exactly how much you were going to spend, or if you anticipate ongoing expenses, a HELOC might be more appropriate. The flexibility to borrow as needed could be valuable in that case. So here are some practical guidelines to consider if you find yourself facing the same question as Gabby did.

Ralph Estep Jr.:
07:43

Number one, choose a home equity loan if you know exactly how much you need to borrow, like in Gabby's case; she knew she wanted to borrow $50,000.

Ralph Estep Jr.:
07:46

If you prefer predictable payments, you know if you want to know exactly what those payments are going to be. If you're comfortable with the idea of a second mortgage and, this is a big one, you want protection from rising interest rates. If we're in a time where interest rates are going up, then a home equity loan is probably your best choice.

Ralph Estep Jr.:
08:10

Now choose a HELOC if your borrowing needs are ongoing or uncertain, if you don't know exactly how much that project is going to cost. Maybe you want more flexibility in how much you borrow. You also need to be comfortable with variable interest rates. And here's the big one, folks: You can resist the temptation to overspend.

Ralph Estep Jr.:
08:29

Remember this: both options use your home as collateral. That's a big deal. So there's a risk of foreclosure if you can't make those payments. So never borrow more than you can afford to repay. So let's do a quick recap. Home equity loans offer a lump sum with fixed rates and payments, while HELOCs provide flexible borrowing with variable rates.

Ralph Estep Jr.:
08:48

The truth is, your choice depends on your specific needs, your financial situation, and, to be honest, your comfort level with different types of risk. I hope this helps you, Gabby, and all of our listeners considering home equity options. Remember, every financial decision should be made prayerfully and with careful consideration for your specific circumstances.

Ralph Estep Jr.:
09:07

Now, tomorrow we're going to be discussing a crucial topic in our digital age: How can I protect myself from identity theft online? You won't want to miss this essential message about safeguarding your financial identity. I'm going to give you some tips on how to do that. Well, if you found today's episode helpful, I'm going to encourage you to visit our website.

Ralph Estep Jr.:
09:25

That's at AskRalph.com. You noticed I said AskRalph.com. Now, usually, I say AskRalphPodcast.com, but we've merged the website. So you can either go to AskRalph.com or AskRalphPodcast.com; it's going to take you to the same place. So when you sign up for our email list, when you go to that website, you receive a free copy of my book.

Ralph Estep Jr.:
09:44

It's right here: Mastering Your Finances. Now, that book normally sells for $10 on Amazon, but it's my gift to you for being a part of our community. And please don't forget to share this episode with friends or family who might be considering home equity options. Your share could be a key in helping someone make a wise financial decision.

Ralph Estep Jr.:
10:01

Now, before we wrap up, let me give you three actionable steps based on today's topic. So if you find yourself in Gabby's position, looking to borrow for a home equity loan or home equity line of credit, here are some things to consider. Number one, calculate your home equity. That's the beginning of this whole process.

Ralph Estep Jr.:
10:17

Subtract your mortgage balance from your home's current value. This is going to give you an idea about how much you may be able to borrow. Now, generally, a lender will let you borrow up to 80% of your home's value with what they call cash-out loans. Number two, if you're considering getting a home equity loan or a HELOC, get quotes from at least three different vendors.

Ralph Estep Jr.:
10:36

It's time to compare their rates, compare their fees and their terms. There are some great online sites where you can compare home equity loan rates. I would recommend BankRate.com. And number three, before making a decision, create a detailed budget. Yep, there goes Ralph with that budget talk.

Ralph Estep Jr.:
10:52

But the truth is, it helps. Make sure you'll be able to repay the loan. You need to make sure it's comfortable, that you don't miss any payments. You don't want to lose your home by making renovations to your home. Well, that's all we have for today, folks. Remember, your questions drive the show. So keep them coming.

Ralph Estep Jr.:
11:08

You can submit your questions on our website or through any of our social media channels. Or simply send an email to Ralph at AskRalph.com. And as I always say, stay financially savvy and God bless you abundantly.