Home Equity Loan vs Home Equity Line of Credit (HELOC): What’s the Difference?

Home Equity Loan vs Home Equity Line of Credit (HELOC): a home equity loan provides a lump sum upfront with a fixed interest rate and a set repayment period, while a HELOC provides a revolving line of credit with an adjustable interest rate and a flexible draw period.

Using this equity, homeowners can finance significant expenses, such as home improvements, education, or debt consolidation. An equity line of credit (HELOC) or a home equity loan are two common ways to access this equity.

This blog post will explain the difference between a home equity loan and a HELOC.

Introduction

Homeowners possess a significant financial asset in their homes. As homeowners continue to pay down their mortgage, their home equity grows.

There are some significant differences between a home equity loan and a home equity line of credit, which homeowners should be aware of before deciding which option to pursue.

What is a Home Equity Loan?

A home equity loan is a type of loan where the borrower uses the equity in their home as collateral. It usually involves a one-time lump sum payment, a fixed interest rate, and a fixed repayment period.

Repayment periods can generally range from 5 to 30 years, depending on the lender and the borrower’s creditworthiness.

A home equity loan is a good choice if the borrower knows exactly how much money they need upfront and prefers a fixed repayment period with predictable monthly payments.

Due to the fact that the borrower’s home secures home equity loans, the interest rates are typically lower than those on credit cards or personal loans.

What is a Home Equity Line of Credit (HELOC)?

As with a home equity loan, a home equity line of credit (HELOC) uses the equity in the borrower’s home as collateral. However, a HELOC is a revolving credit line, similar to a credit card, rather than a lump sum loan.

In addition to paying interest only on the amount borrowed, the borrower can access funds up to a predetermined credit limit as necessary.

In most cases, HELOCs have an adjustable interest rate that fluctuates according to the prime rate and the borrower’s creditworthiness.

Typically, a HELOC has a repayment period of between 10-20 years, followed by a draw period of 5-10 years during which the borrower can access funds whenever necessary.

Borrowers with ongoing expenses, such as home improvements and college tuition, are more likely to benefit from a HELOC. Since a borrower can access funds as needed, up to their credit limit, a HELOC provides more flexibility than a home equity loan.

Because the interest rate is adjustable, the monthly payment may fluctuate over time, making it more difficult to budget.

Differences between Home Equity Loan vs Home Equity Line of Credit (HELOC)

There are some key differences between a home equity loan and a home equity line of credit, including the repayment terms and the flexibility of accessing funds.

A home equity loan has a fixed interest rate and a set repayment period, whereas a HELOC has an adjustable interest rate.

In the case of a home equity loan, borrowers receive a lump sum upfront and begin repaying the loan immediately. During the draw period of a HELOC, the borrower can access the funds as necessary, and the borrower only has to pay interest on the amount borrowed.

With a HELOC, the borrower can expect a fixed monthly payment throughout the life of the loan. Based on the interest rate, the repayment period for a HELOC starts after the draw period.

Home equity loans typically have fixed interest rates set when the loan is created. In contrast, HELOCs have adjustable interest rates that fluctuate based on the prime rate and creditworthiness of the borrower.

Home equity loans have fixed interest rates, typically set at the time of loan origin. While the interest rate on a HELOC is typically lower than that on a credit card or personal loan, it can fluctuate over time, making budgeting more difficult.

Home Equity Loan vs HELOC

The table shows that the main differences between a home equity loan and a HELOC are the loan type, interest rate, repayment terms, payment terms, credit limit, and best use.

The payment terms for a home equity loan are monthly payments, while a HELOC requires interest-only payments during the draw period. The credit limit for a home equity loan is fixed, while a HELOC has a revolving credit limit.

A home equity loan is best for one-time expenses, while a HELOC is best for ongoing or unpredictable expenses.

To qualify for a home equity loan or HELOC, you must meet the lender’s requirements, have good credit, and have equity in your home.

For a home equity loan, the lender will require an appraisal of your home to determine its current value, and income verification and other documentation may also be required. The lender will also evaluate your credit score, debt-to-income ratio, and other financial information.

For HELOC, however, more documentation may be required, such as income verification and proof of homeowners insurance. The lender will also consider your credit score, debt-to-income ratio, and other financial information when determining whether you qualify.

How quickly you provide your lender with the necessary documentation and information can also affect the time it takes to approve your home equity loan or HELOC.

A higher credit score can increase your chances of getting approved and receiving more favourable loan terms, such as a lower interest rate.

However, even if you have a lower credit score, you may still be able to qualify for a home equity loan or a HELOC, although you may receive less favourable terms or be required to pay a higher interest rate. Reviewing your credit score and report before applying for a home equity loan or a HELOC is important.

Paying off the loan early can save money on interest charges and reduce your overall debt. However, reviewing your loan terms and checking for any prepayment penalties before paying off the loan early is important.

Some lenders may charge a fee for paying off the loan before the scheduled due date, so it’s important to understand the terms of your loan agreement.

Nevertheless, you must weigh the risks and benefits of using your home as collateral. You could lose your home if you cannot make payments on the HELOC or home equity loan.

Maintaining discipline after consolidating your debt is also important to avoid adding new credit card balances.

According to the new tax law, however, homeowners may only deduct the interest if the funds were used to renovate or add to their home. In the event that the loan was used for another purpose, such as paying off credit card debt or buying a car, the interest is no longer deductible.

To better understand the potential tax benefits of a home equity loan or HELOC, you should consult a tax professional.

You should consider the fees of each option before deciding which one to pursue. Closing costs, appraisal fees, and other fees may be associated with a home equity loan and HELOCs.

To determine which option is most cost-effective for your situation, it is important to compare fees and interest rates.

You should also consider the risks associated with using your home as collateral. If you default on the loan, your home could be lost. Before taking out either a home equity loan or a HELOC, ensure you have a solid repayment plan.

Choosing the right financing option depends on your personal financial circumstances and needs.

Conclusion: Home Equity Loan vs HELOC

The equity in your home can be accessed by taking out a home equity loan or a home equity line of credit. A home equity loan provides a lump sum upfront with a fixed interest rate and a set repayment period.

In contrast, a HELOC provides a revolving line of credit with an adjustable interest rate and a flexible draw period. Before making a decision, it is important to consider your individual financial situation and weigh the pros and cons of each option.

References

1. Experian. “What Are the Pros and Cons of a Home Equity Loan?“
2. Experian. “What Is a Home Equity Line of Credit (HELOC)?”
3. Investopedia. “Is Interest on a Home Equity Line of Credit (HELOC) Tax Deductible?“
4. Wikipedia. “Home equity line of credit“

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