Homeownership has its perks. Once you’ve owned your home for a while and made regular payments, you build up equity. If you run into a financial need, you can borrow against your equity using a home equity line of credit or a home equity loan. Take a look at what those are and whether they’re right for you.
What is a Home Equity Line of Credit (HELOC)?
A home equity line of credit (HELOC) offers you a credit line based on your home’s equity. What exactly is equity? Your equity is the value of your home less the balance of your mortgage.
Let’s say you own a home valued at $175,000. You owe $100,000 on your mortgage. That means you have $75,000 in equity in your home ($175,000 - $100,000 = $75,000).
With a HELOC, a lender will look at the amount of equity you have, your income, your credit history and your overall debt. Based on those factors, the lender may approve you for a credit line. Lenders typically don’t allow you to borrow more than 85% of your home’s equity. Based on the example above, the most you would be approved for is $63,750.
A credit line is similar to a credit card so you’re approved for the maximum amount you can withdraw. You don’t have to withdraw it all at once. You can withdraw what you need when you need it. Once you borrow, you typically have to make payments, but those payments may be interest only. You’ll have a set period to borrow funds, which is known as your draw period. After your draw period ends, you must start making payments. This is called your repayment period and it may last for 20 years or more.
What is a Home Equity Loan?
A home equity loan is similar to a HELOC, in that you’re borrowing against the equity in your home. Unlike a HELOC, you borrow a lump sum of money and then you begin paying it back right away.
As with a HELOC, you can typically borrow up to 85% of the equity in your home. Lenders look at your credit, income and debt when they decide whether to offer you a home equity loan. Home equity loans typically have a fixed interest rate, which means it always stays the same. The monthly payments also stay the same.
Comparing a Home Equity Line of Credit vs. Home Equity Loan
A home equity line of credit (HELOC) and a home equity loan are both types of loans that allow you to access the equity in your home, but they have some key differences.
When deciding between a HELOC and a home equity loan, consider your financial goals, borrowing needs, and preferences for repayment terms and interest rate stability. It's recommended to compare offers from different lenders to determine which option suits your circumstances best. Additionally, it may be helpful to consult with a financial advisor or loan officer who can provide personalized guidance based on your specific situation.
Let's break down how they compare:
Structure
A HELOC is a revolving line of credit, similar to a credit card. It provides you with a maximum borrowing limit, and you can borrow against that limit as needed during a specific draw period, typically 5 to 10 years. You can borrow, repay, and borrow again within a specific draw period. A home equity loan, also known as a second mortgage, is different in that it provides you with a lump sum of money upfront. This loan is repaid over a fixed term, usually with a fixed interest rate and monthly payments.
Access to funds
With a HELOC, you can access funds as needed during the draw period by writing checks, using a card, or transferring funds electronically. You can borrow the entire available amount or a portion of it, depending on your requirements. However, since a home equity loan gives you the entire loan amount upfront as a lump sum, you cannot access additional funds beyond the loan amount. If you need more money, you'll need to apply for a new loan.
Repayment schedule
With a HELOC, during the draw period, you only need to make interest payments on the amount you've borrowed. After the draw period ends, a repayment period begins, typically 10 to 20 years, during which you repay both principal and interest. The interest rate on a HELOC is usually variable, meaning it can fluctuate over time. With a home equity loan, you start repaying the principal and interest immediately after receiving the lump sum. The loan is repaid in equal monthly installments over the agreed-upon term. The interest rate is typically fixed, providing more stability in terms of monthly payments.
Interest rates
The interest rate on a HELOC is usually variable, meaning it can change over time based on market conditions. The rate is often tied to a benchmark, such as the prime rate, plus a margin determined by the lender. The interest rate on a home equity loan is usually fixed, meaning it remains the same throughout the loan term. This provides predictability in terms of monthly payments.
Flexibility
A HELOC offers more flexibility since you can borrow and repay multiple times during the draw period. It can be suitable if you have ongoing or unpredictable expenses, such as home renovations or education costs. Since home equity loan provides a one-time lump sum, it's better suited for specific expenses where you know the exact amount you need upfront, such as debt consolidation or a large purchase.
Navigating the Decision Between a HELOC and Home Equity Loan
Remember, leveraging home equity financing is a significant decision, and it's advisable to consult with a financial adviser or mortgage professional who can provide personalized guidance based on your circumstances. By carefully assessing your needs and considering the pros and cons of each option, you can make an informed choice that aligns with your financial objectives and helps you maximize the benefits of your home equity line.
Try Unlock
Unlock isn’t a line of credit or a loan. When you reach out to Unlock, they accept credit scores as low as 500 and make an investment in your home. You can use that cash for anything you need, and you don’t pay the platform back until you sell the house. This means you can allow the house to rise in value and still get the benefits of a home equity loan or line of credit without adding monthly payments, closing costs and stress to your plate.
Frequently Asked Questions
What is the difference between a home equity line of credit and a home equity loan?
A home equity line of credit (HELOC) is similar to a credit card in that it allows you to borrow money as you need it, up to a predetermined limit. A Home Equity Loan, on the other hand, is a lump-sum loan that is typically repaid over a fixed term.
What are the benefits of a home equity line of credit?
A home equity line of credit offers flexible borrowing options as well as a low-interest rate and potential tax benefits. You only pay interest on the amount you borrow, which can be an advantage if you don’t need all the funds upfront.
What are the benefits of a home equity loan?
A home equity loan provides a lump-sum payout, which can be beneficial if you need to make a large, one-time purchase or have a fixed project budget. Your monthly payments are typically fixed, making it easier to budget and plan for expenses.
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