Home equity loans or a home equity line of credit (HELOC) allows eligible homeowners to access a part of the equity in their home, which they can then use to solve (or simply patch up) a myriad of financial issues. This can be also referred to as a second mortgage.
A home equity loan, like most loans, provides a single lump sum payment which the borrower must pay back with interest within a certain period of time. Both the interest rate and payment amount typically remain fixed for the lifetime of the loan.
A HELOC acts much like a credit card. Borrowers are pre-approved for a certain amount that they can borrow as needed. Payments are distributed via check or with an actual credit card provided by the lender. The interest rates associated with a HELOC are typically variable, and your payment amounts will vary depending on how much you've borrowed. The HELOC will also need to be repaid during a pre-set term.
Homeowners consider home equity loans and HELOCs for a wide variety of uses, some of which could be considered smarter than others. Many home equity loans and HELOCs are used for home improvement or construction loans. Using the equity in your home to improve your home is actually considered one of the smarter ways to use this money, though it's important to have a budget plan for home improvements so that your costs stay as low as possible.
Some homeowners take out home equity loans or HELOCs in an effort to give their retirement budget plan a boost, but this can be a risky strategy for retirees. It is a risk because the loan may have to be paid back within a set period of time, and if you default on the loan, you risk losing your home. If you need additional funds to ensure that you retire comfortably, there are other options that may work better for you.
Other homeowners want to tap the equity in their home in order to invest in the stock market, start small business, pay off credit cards, or finance their children's college tuition. There are certain risks associated with all of these plans. It is likely that your home is your largest investment and asset. With that you will want to carefully consider your options before investing part of the value of your home in your child's education or the stock market, swapping credit card debt for a home equity loan, or leveraging your home to start a new business.