HELOC vs. Home Equity Loan – Which One Is Better?
Home equity loans and home equity lines of credit (HELOCs) are loans secured by a borrower’s home. However, they differ from each other in some important ways. Let’s take a look at their similarities and differences so that you can determine which one is better for you.
An Explanation of Each
A HELOC is a revolving credit line that you can borrow against up to a preset limit. There are two phases to HELOCs. The first is the draw period when you can tap into the credit line as needed and have to make payments only for the interest you owe. The second phase is the repayment period where you must start paying off the principal as well as the interest.
Home Equity Loan
This is a fixed-term loan given by a lender that’s based on your home equity. Equity is the difference between what’s owed on a mortgage loan and the home’s market value. When you are approved for the requested amount, you receive the money in a lump sum.
The Differences Between Home Equity Loans and HELOCs
- Are revolving credit lines that come with adjustable interest rates and varying payment amounts.
- As long as you make interest payments, you can withdraw funds from your credit lines as a borrower.
- Up to a preset credit limit, borrowers can tap into their equity.
- Often useful as a home improvement loan because they allow for more flexibility to borrow what you need. For example, if it turns out you need more money than expected, you can turn to your line of credit. As long as you still have availability, you don’t have to reapply for another loan.
Home Equity Loans
- Come with fixed payments and interest rates for the loan’s term.
- Gives the borrower a lump sum upfront. After this, you’re expected to make fixed payments during the course of the loan.
- Helpful if you know how much you need to borrow for a designated expense. You’re guaranteed a specific amount, which you receive in full when the loan is advanced.
- Home equity loans often help with larger expenses like college tuition, debt consolidation, or home renovation.
- You consolidate what’s owed on credit cards or other higher-rate debts in a single loan. Since your home is used as collateral for HELOCs, these loans have lower interest rates.
While there are differences in HELOC vs. home equity loans, both allow access to funds for a variety of circumstances like debt consolidation, home repairs, or college funds.
The Pros and Cons of HELOCs
A “pro” of HELOCs is that they work similarly to a credit card: You have a set amount of money available to borrow and you can take what you need whenever you need it.
Also, you’ll only pay interest on the amount drawn, as opposed to paying interest on the entire amount of the loan.
But a “con” is that unlike home equity lines of credit, the interest rate for HELOCs is variable and adjusts according to movements in the market. Because of this, your monthly payment can vary and can increase if interest rates rise. So you need to be able to cover your payments should this situation arise.
As with home equity loans, you could very likely lose your home if you fail to make your scheduled payments.
The Pros and Cons of Home Equity Loans
One big advantage of a home equity loan is that it comes with a fixed interest rate. This means your monthly payment remains the same, which makes it easier to determine your budget. Since it’s a lump-sum equity draw, this loan would be a reliable financial source for bigger projects and expenses.
On the downside, if you tap into all of your home equity and property values decline in your area, you run the risk of going “underwater” on your loan. This means your loan is greater than your home’s value. Also, if you are suddenly facing an emergency and need more cash, but you’ve used up your loan, you can’t make a withdrawal without taking out another loan.
Most importantly, if you don’t make your payments, you could lose your home because it’s the collateral you leveraged to get the loan in the first place.
Which One Is Better for You?
The official terms of home equity loans and HELOCs differ for each lender. Make sure you understand the terms you’re agreeing to and explore all options before making a final decision.
Here’s a list of questions to ask to determine if a home equity loan is best for you.
If your answer is yes to the following questions, a home equity loan could be a good fit for you.
- Do you know the exact amount you need for your planned expenses?
- Do you want to consolidate debt but don’t want to open a new credit line?
- So you live on a fixed income and are prepared to pay a monthly debt? If so, could you handle unplanned fluctuations?
On the other hand, if you answer yes to the questions below, a HELOC might be the better choice.
- Do you need a revolving credit line to borrow from and can cover the loan payments should the variable interest rate rise?
- Do you want a credit line ready for emergencies but don’t need money immediately for something else?
- Do you spend money wisely and control your budget?
Once you’ve decided on a HELOC vs. home equity loan, read the blog below to see the benefits your loan will give you!