HELOC Vs. Home loan: how does it work?
HELOC Vs. Home loan: how does it work?

Home equity lines of credit (HELOCs) and home equity loans are loans that use your home as collateral, and both can be great for borrowing money if you’ve paid off a significant portion of your mortgage. A HELOC is a line of credit that allows you to borrow money as needed with a variable interest rate, while a home equity loan is a lump sum that is paid up front and repaid in installments. fixed.

Most home equity loans and HELOCs allow you to borrow up to 85% of the value of your home, minus your outstanding mortgage balance. These financial options tend to have low interest rates and fair terms because they use your home as collateral. Before settling on a home loan or line of credit, shop around for an option with the lowest fees — or no fees if possible.

What are the differences between a HELOC and a home equity loan?

If you have equity in your home and want to borrow money, you can choose a HELOC loan or a home equity loan. Below are some of the main differences between these options.

Home Equity Loan HELOC
Interest rate Fixed Variable
Monthly payments The same every month Changes over time
Disbursement of funds Initial lump sum As required
Repayment Terms Starts as soon as the loan is disbursed Interest-only payments during the drawing period; repay principal and interest afterwards

What is a home equity line of credit?

A home equity line of credit (HELOC) is a line of credit similar to a credit card. You can borrow up to a specific amount of your home’s equity and repay the funds slowly over time.

HELOCs allow you to access money when you need it and pay it back with variable interest. Because of this, you are not locked into a specific monthly payment. That’s good news for homeowners who aren’t sure how much they need to borrow and want to pay interest only on the money they have access to.

Benefits

  • Borrow only the money you need.
  • Many HELOCs are free.
  • Flexible repayment options.
  • Possibility of tax deduction.

The inconvenients

  • Variable interest rates change with market fluctuations.
  • Having a long-term line of credit risks overspending and having more debt to pay off.
  • Could lose your home if you default on the HELOC.

If you want the ability to borrow as much or as little money as you need over time, a HELOC makes sense. You might want to go this route if you’re not sure how much it will cost to fund your project or business.

What is a home equity loan?

A home equity loan is a secured loan that lets you borrow against the equity in your home with a fixed interest rate and repayment term. Your interest rate depends on your credit score, payment history, loan amount and income. If your credit improves after getting a home equity loan, you may be able to refinance at a lower interest rate.

How you use the money from a home equity loan is up to you. Some use it to pay for major repairs or renovations, like adding a new room, gutting and remodeling a kitchen, or updating a bathroom. You can also take out a home equity loan with a low fixed rate to pay off high interest credit card debt.

Benefits

  • A fixed interest rate means the same predictable monthly payment.
  • Borrow a lump sum that you can use for anything.
  • Some home equity loans have no fees.
  • Loan interest may be tax deductible.

The inconvenients

  • The best home equity loan rates and terms go to consumers with good or excellent credit, or a FICO score of 670 and above.
  • You need a lot of equity to qualify, usually 15-20% or more.
  • If property values ​​drop, your mortgage could be upset, meaning you owe more than your home is worth.
  • You could lose your home if you don’t repay the loan.

If you have a specific project in mind and you know exactly how much it will cost you, a home equity loan can be a smart choice as it can provide you with a lump sum of cash. Just make sure you don’t plan to borrow more money in the near future.

How do I choose between a home equity loan and HELOC?

A home equity loan may be preferable if:

  • You know the cost of your project and need to borrow a lump sum.
  • You prefer a fixed interest rate that will never change.
  • A fixed monthly payment best suits your budget.
  • You want to consolidate high interest credit card debt to a lower interest rate.

A HELOC might be better if:

  • You want to borrow as little or as much as you want, when you want.
  • You have upcoming expenses such as tuition and don’t want to borrow until you’re ready.
  • You don’t mind if your payment fluctuates.

What is the impact of the coronavirus on home loans and HELOCs?

You can get a home equity loan or line of credit when interest rates are currently at rock bottom, even though the economy is still recovering from the COVID-19 pandemic

But keep in mind that a mortgage or line of credit acts like a second mortgage. If a borrower is laid off and does not repay the loan, the primary mortgage must first be paid off using the current value of the home (which may have fallen during a recession).

Only after the first mortgage has been paid in full can the home equity lender recover the outstanding debt on the remaining value of the collateral, which may not cover the entire loan. For this reason, it may be difficult to qualify for a home equity loan while the coronavirus pandemic continues. Some lenders have stopped home equity products altogether.

How do I get a HELOC or home equity loan?

Although eligibility requirements for home equity products have tightened as a result of the coronavirus pandemic, there are still options available to eligible borrowers:

  • Considerable equity in your home: You will likely need to have at least 20% equity in your home, or an 80% loan-to-value ratio, which means that your mortgage balance and any existing home equity loans total no more than 80% of the value of your home.
  • Good credit: Although lender requirements vary, in general you’ll want to have a credit score in the mid-600s to qualify and a score above 700 to get the best interest rates and terms. Some lenders also require a higher credit score for larger loan amounts.
  • Low debt: Many home equity lenders require a debt to equity ratio of 43% or less. This means that your monthly payments are no more than 43% of your gross monthly income.
  • Sufficient income: You must show that you can repay your loan, although most lenders do not disclose their income thresholds.
  • Reliable payment history: A long history of on-time payments on other bills can help you qualify for a home equity loan or HELOC. A history of late payments makes eligibility more difficult.

Can you have a HELOC and a home equity loan?

Theoretically, there is no limit to the number of home equity loans or lines of credit you can hold at one time. But it will be more difficult to qualify with each new application because you will have less and less equity to exploit with each loan.

For example, if you have a home worth $500,000 and you have two home equity loans totaling $425,000, you have already borrowed 85% of your home’s value – the ceiling for many home equity lenders. home equity.

Lenders may also charge higher interest rates on additional loans or lines of credit, especially if you apply for a second loan from the same lender.

At the end of the line

Home equity loans and home equity lines of credit can allow you to borrow money against the equity in your home. But they are not the same. Before deciding which option is best for you, think about the purpose of the funds, how much you need, and whether or not you want to borrow more in the future. Once you’ve made up your mind, get your credit in good shape and shop around for the best rate.

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