Wednesday, February 28, 2024
HomeLoansHome Equity Loan or HELOC: Key Differences

Home Equity Loan or HELOC: Key Differences

Looking to renovate your home, cover tuition expenses or consolidate high-interest debt? Your home could help you obtain the funds you need. You may be able to leverage your home equity and turn it into cash through two popular options: a home equity loan or a home equity line of credit (HELOC).

Let’s take a look at what these two financing options are, their key differences and if one could be right for you.

What is a Home Equity Loan?

A home equity loan lets you borrow against the equity in your home, which is the gap between your home’s current value and the remaining balance on your mortgage. The loan payments get added onto your mortgage balance, which is why a home equity loan is also commonly called a “second mortgage.” Home equity loans usually have fixed interest rates, and the rate on your current mortgage remains unchanged.

You’ll receive a lump sum of funds and can immediately put them to use. As for repaying your loan, you’ll have to make two separate payments—one for your existing mortgage and another for the home equity loan. 

What is a HELOC?

A HELOC lets you access funds based on your home equity and repay them with a variable interest rate. A HELOC is similar to a credit card, except you’re borrowing against your home equity. It’s a revolving credit line you can tap into as needed and pay back. 

How Do They Compare?

While both home equity loans and HELOCs allow you to borrow from your home equity, there are notable differences in their structure, interest rates and flexibility. 

Loan Structure

Home equity loans and HELOCs have distinct characteristics in terms of how they are structured. How can you access your funds? How do you repay what you borrow? Here’s a breakdown. 

Home Equity Loans Resemble Your Existing Mortgage Structure

With a home equity loan, funds are usually dispersed upfront in a lump sum to be used as you wish. 

  • You’ll make consistent fixed monthly payments to repay the loan over the agreed-upon term.
  • Similar to a traditional mortgage, closing costs are required, and your payments cover both the principal and interest.
  • You may be eligible for tax deductions on home equity loan interest if your total mortgage debt is $750,000 or below, you itemize deductions and the loan is applied to significant home improvements.

You May Like to Read: When is the Right Time to Refinance?

HELOCs Have a Unique Two-Phase Structure

A HELOC gives you a revolving credit line based on your home equity. You repay with interest on whatever you borrow. HELOCs have a two-phase structure: the draw and repayment periods.

Phase One: The Draw Period

During this first phase, the credit line is open, and you can access your funds as needed. The following are some points to keep in mind:

  • The draw period typically lasts between 5 and 15 years.
  • Minimum payments are required.
  • During this phase, you may only need to cover the interest on what you’ve borrowed, but this may lead to larger minimum payments in phase two.
  • Funds revolve but aren’t limitless; hit the limit, repay some, then borrow again.

Phase Two: The Repayment Period

After the draw period, the repayment period starts and so do recurrent monthly payments. 

  • The home equity line is closed and no more borrowing is allowed.
  • Payment amounts vary based on whether interest was paid during the draw period and its duration.
  • Variable interest rates may impact payment amounts.

Phase one and phase two are not evenly split. For example, a 30-year HELOC may have a 10-year draw period and a 20-year repayment period. Understanding when phase one ends can help you plan financially. 

Interest Rates

As a homeowner, you may already understand how interest rates play a significant role in how much you’ll pay for your loan over time. Here’s an overview of how home equity loans and HELOCs compare in terms of interest rates. 

Home Equity Loan Rates Are Usually Fixed

Home equity loans often have fixed interest rates, which ensures a predictable, consistent monthly loan payment amount until the loan is paid off entirely. And since the loan is essentially a second mortgage, the interest rate on your current mortgage stays the same.

HELOCs Have Variable Interest Rates

HELOCs Have Variable Interest Rates

HELOCs typically offer lower interest rates than home equity loans. However, HELOCs use variable rates, which means the interest rate is subject to fluctuations based on specific benchmark rates and the current market conditions. Your payments due will be influenced by both the changes in interest rates and the amount of money you’ve used from the line of credit.

Flexibility

When comparing home equity loans vs. HELOCs, assessing if their flexibility meets your funding requirements is essential.

A Home Equity Loan Has a One-Time Disbursement

Home equity loan funds are a one-time disbursement. While you can spend the funds on anything, homeowners typically use them for a single significant expense, such as a major home renovation or repair, debt consolidation or college tuition.

Once you receive and use your funds, they do not replenish, and you make regular fixed payments toward repaying the loan. Whether you spend all the money or not, the funds will need to be repaid with interest. 

A HELOC Is a Revolving Line of Credit 

A home equity line of credit allows you to withdraw funds as needed and repay only the borrowed amount along with accrued interest. Once you repay the funds, you can access them repeatedly until the draw period ends, giving you borrowing flexibility.

Like a home equity loan, you can utilize the funds for a single significant expense, but people often secure them as a safety net. HELOCs can be a resource for quick funds in the case of an emergency or other unforeseen expense. 

Deciding What’s Right for You

For homeowners seeking increased spending flexibility, a home equity line of credit could be a practical option. However, if you require a lump sum of immediate funds and prefer fixed interest rates and predictable monthly payments, a home equity loan might be a more suitable choice.

How to Get a Home Equity Loan or Line of Credit

Ready to leverage your home equity for accessible cash? Talk to a licensed loan officer. They can help you compare your financing options and guide you through the process.

If you’ve been putting off a home renovation or are looking to consolidate debt or fund a big-ticket expense, unlocking your home equity could be the key to unlocking opportunities.

More from MoneyVisual

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Recent Posts

Most Popular

Educational Topics