Fixed-Rate Mortgages vs. Home Equity Lines of Credit
A fixed-rate mortgage has an interest rate that stays the same throughout the loan’s duration. Although the monthly principal and interest payments vary, the overall payment remains the same, making budgeting for homeowners simple.
The main benefit of a fixed-rate mortgage is that it protects the borrower from unexpected and considerable increases in monthly mortgage payments. These loans are simple to understand and vary little between lenders. The disadvantage with fixed-rate mortgages is that when interest rates are high, payments become unaffordable.
Although the interest rate is fixed, the total amount paid varies on the mortgage length. Traditional lenders offer fixed-rate mortgages for 30, 20, and 15 years.
Less than 3% down payment on a 30-year mortgage! The low monthly payment comes at a large overall cost because the extra decade or more is devoted to paying interest.
Shorter-term mortgages have greater monthly payments, so the principle is repaid faster. Also, shorter-term mortgages have lower interest rates, allowing more principles to be returned with each payment. Shorter-term mortgages are so cheaper overall.
A fixed-rate loan (also known as a term loan) has an interest rate that remains constant throughout the loan’s life. For example, a five-year loan with a 15-year amortization. The interest rate would be “locked-in” for five years.
These loans are used to buy fixed assets (those that will be used for 60 months or more). A fixed-rate loan has equal monthly payments for interest and principal that do not alter over the loan’s tenure. A contract sets the loan’s principle and interest rate. These are termed fixed-rate loans. These tie the lender and the borrower. A lender cannot demand repayment of a fixed-rate loan if the borrower makes scheduled payments. Deferred payment is also not permitted without the lender’s authorization.
If the lender agrees to early loan repayment, the borrower must normally pay high penalty fees. The penalty costs make up for lost matching funds earnings.
Fixed-rate loans help businesses budget by providing predictability.
A HELOC allows you to borrow money against your home’s equity. With a line of credit, you can borrow money for significant purchases and pay only interest on what you have borrowed, rather than the full loan amount.
Home Equity Loan (HELOC)
Home equity loans are unique. They are revolving funds, like a credit card, that you can access whenever you choose. Most banks allow you to access your funds via internet transfers, checks, or a credit card linked to your account. Aside from the low (or no) closing costs, they have variable interest rates, while some lenders provide fixed rates for a set number of years.
The flexibility of credit lines has both perks and cons. Untapped money do not incur interest and can be accessed at any time. So it’s a wonderful emergency fund (as long as your bank doesn’t have a minimum withdrawal requirement).
If you’ve lost your work due to the coronavirus, need cash, and own your house, a HELOC may be a viable alternative. However, Wells Fargo and JPMorgan Chase announced application freezes for new HELOCS in the spring of 2020.
Most HELOCs have two phases. After a draw period of 10 years, you can use your available credit as you like. Regular interest-only payments are required during the draw period, though you may be able to pay extra to reduce the principal.
It’s possible to extend the draw period. If not, the debt enters repayment. You can no longer borrow funds and must make regular principal-plus-interest payments until the sum is gone. In most cases, lenders want a 20-year repayment period after a 10-year draw period. During the payback period, you must refund the full amount borrowed plus interest. Some lenders may give borrowers flexible repayment choices.
HELOCS differ from regular credit lines in many ways and offer advantages. Due to the interest-only payments in the draw period, repayment payments might nearly quadruple. For example, a $80,000 HELOC with a 7% APR would cost roughly $470 per month for the first ten years when only interest is due. That rises to about $720 each month when payments begins.
Payment shock can occur when a new payback cycle begins for many unprepared HELOC borrowers. If the amounts are significant enough, it can trigger default. If you don’t pay, you could lose your home.
Unlike a traditional loan, you set up a home equity line of credit in advance and utilize it as needed. Like a credit card, a HELOC uses your home as collateral.
A HELOC has a credit ceiling and a borrowing period of 10 years. During that period, you can use your credit line to withdraw funds up to your credit limit. You just use the funds when you need them and can keep using them as you repay them.
You only pay interest on funds used.
Most HELOCS have adjustable rates. Those rates are linked to a benchmark rate and can change.
During the borrowing period, you must make minimum monthly payments on your debt. Some HELOCS offer interest-only payments. Others need minimum principle and interest payments.
After the borrowing time finishes, you’ll pay back the remaining debt on your HELOC, plus interest. Repayment is normally 10-20 years.
If you’ve read thus far, you should know the distinction between fixed rate loans and home equity lines of credit.