Is a Home Equity Loan or Line of Credit Right for Me?
Home equity financing uses the equity in your home to secure a loan. For this reason, lenders typically offer better interest rates for this type of financing than they do for other, unsecured types of personal loans.
The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspended from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.
A home equity loan (often referred to as a second mortgage) is a loan for a fixed amount of money that must be repaid over a fixed term. Generally, a home equity loan:
- Advances the full amount you borrow at the beginning of the loan’s term
- Carries a fixed rate of interest
- Requires equal monthly payments that repay the loan (including the interest) in full over the specified term
With a home equity line of credit (HELOC), you’re approved for revolving credit up to a certain limit. Within the parameters of the loan agreement, you borrow (and pay for) only what you need, only when you need it. Generally, a HELOC:
- Allows you to write a check or use a credit card against the available balance during a fixed time period known as the borrowing period
- Carries a variable interest rate based on a publicly available economic index plus the lender’s margin
- Requires monthly payments that may vary in amount, based on changes in your outstanding balance and/or the prevailing interest rate
The best type of loan for you will depend on your individual circumstances. Generally, if you’ll need a fixed amount of money all at once for a certain purpose (e.g., remodeling the kitchen), you might want to take out a home equity loan.
Some HELOCs may cap the monthly payment amount that you are required to make, but not the interest adjustment. With these plans, it’s important to note that payment caps can result in negative amortization during periods of rising interest rates. If your monthly payment would be less than the interest accrued that month, the unpaid interest would be added to you principal and your outstanding balance would actually increase, even though you continued to make your required monthly payments.
