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Step 1
First, know the basic differences between the two types of loans. A HEL is basically a second mortgage with a low fixed rate. You receive a large sum of money and pay it back at regular intervals, just as you do with a first mortgage.
A HELOC is more like a credit card with a huge limit. It has an adjustable rate based on the prime rate, and you are not tied to a fixed payment schedule. You can make only the minimum interest payments each month, if you so choose. -
Step 2
Consider your ability to repay the loan. If you can easily make fixed payments every month, then a home equity loan is a safe bet. If you can't predict your ability to pay, and like the flexibility of credit, a home equity line of credit may be better.
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Step 3
Consider how rates fluctuate in adjustable rate loans. Home equity lines of credit usually start out with attractive teaser rates that rise later. If you only need a small line a credit and can pay it off quickly, a line of credit may be a better value.
If you like the security of a fixed rate, go with a traditional home equity loan. -
Step 4
Understand that a line of credit is easier to qualify for than a regular home loan. For a HELOC, you may only need to own as little as 5%-10% in order to get a line of credit equal to the value of your home. But for a HEL, there is a 20%-25% ownership minimum.
(For a 30-year mortgage at 6%, it takes about 7 years to own 10% equity, and about 11 years to own 20% equity. With a higher rate, it takes longer to build equity.) -
Step 5
Research loan and credit line offers from different lenders. There are additional terms that vary from bank to bank, and you have a lot of flexibility in choosing the length of the loan period.
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Step 6
Don't forget to factor in the cost of a home appraisal. Since the amount you can borrow is proportional to your home's current value, you will have to pay for an appraisal to determine its worth.
