Interest rates have been soaring so more borrowers are choosing a HELOC or home equity loan to get pull out cash from their equity of their property. Before taking out a second mortgage against your property, you need to understand the benefits and risks of home equity loans and lines of credit. You need to learn which home equity program is best to meet your financial needs before making such an important decision.
What is the Difference Between the Home Equity Loan and the Line of Credit HELOC?
Many homeowners do not know the difference between a home equity loan and HELOC. While both of these types of home equity financing have many similarities and benefits, there are a few major differences.
The RefiGuide helps borrowers educate themselves on the pros and cons of both equity loans and home equity credit lines. The interest rate is calculated differently between an equity loan and a HELOC. The home equity loans is an installment loan that carries a fixed interest rate and the HELOC has a variable interest rate and acts like a revolving line of credit. A home equity loan provides borrowers with a fixed monthly payment with a fixed rate and a lump sum of money.
Conversely, HELOC offers the flexibility of accessing funds as needed, but they often come with an adjustable interest rate. When the interest rates are trending upward then the home equity line of credit becomes riskier, but it depends on what you are using your home equity for. We will outline the primary distinctions and commonalities between the two popular finance products and assist you in determining which one aligns best with your financial objectives.
Compare Home Equity Loan vs Line Of Credit Terms and Rates
We suggest the HELOC when you are looking to finance home improvements, remodeling and repairs. It’s no secret that home renovation projects are difficult to budget for the flexibility of the HELOC makes sense for this purpose. Projects that increase living space, renovate outdated rooms such as kitchens or baths are good financing fits with the an equity line of credit.
Life has a tendency to get expensive, especially when you least expect it. As a homeowner, it often seems that you fix one problem only to see another pop up in its place. A leaky roof? A busted air conditioner? Plumbing problems? Whether you have a legitimate fixer-upper on your hands or you’re simply looking to update parts of your property or pay other expenses, money is a significant factor in making these changes. That’s why it’s important for homeowners to understand what are sometimes seen as risky methods to cover such costs — obtaining a HELOC (Home Equity Line of Credit) or a Home Equity Loan (commonly called a second mortgage).
In most instances we suggest the home equity loan for refinancing loans and debt consolidation. If you are looking for a responsible way to consolidate high interest credit cards, student loans, and other adjustable rate personal loans, we recommend the home equity loan because it features a fixed interest rate with a fixed monthly payment.
The Pros and Cons of a HELOC Line of Credit
The terms and conditions of your home equity line of credit will vary from a home equity loan, most notably where the interest rate is concerned. According to NerdWallet, HELOCs often start with a lower interest rate with one big caveat — that rate is adjustable, or variable, which means it can go up and down and affect your monthly payment in kind.
The adjustable-rate HELOC offers many benefits to homeowners. First, it provides flexibility in managing finances, as you can choose to pay only the interest during the initial draw period, usually around ten years. This can result in lower monthly payments and more control over your budget. Additionally, the funds from the HELOC credit line can be used for various purposes, such as house improvements, college, or bill consolidation. The interest paid on the HELOC used to be tax-deductible. However, it’s important to carefully manage your finances and have a solid repayment plan in place to make the most of an Interest-Only HELOC.
Much like a credit card company, some HELOC lenders will take a portion of what you owe and hold it at a fixed (or introductory) rate. But the balance of your HELOC will ultimately be at a variable rate, meaning you might owe more on your monthly payment than you initially thought. Shop for Today’s HELOC Rates.
Here are other pros and cons of obtaining a home equity line of credit:
- HELOCs can be used to pay for home repairs, remodeling and construction.
- They often include two main periods of repayment. One, the draw period, means you only pay interest due on the money borrowed. When you enter the repayment period, the loan converts to a schedule where both principal and interest are due.
- Home equity lines often have lower interest rates than a personal loan or credit card, which means you could be a lot better off financially while using one.
- You can write a check with a HELOC line.
- HELOCs offer flexible opportunities to pay contractors as needed. (That’s why these are a very popular home improvement loan.)
- The interest on your HELOC might be tax-deductible if the money was used to make home improvements.
- The HELOC offers interest only payments which increase your cash flow.
- A HELOC lines of credit might require a number of upfront costs, such as an application fee, appraisal, title search, and more (almost like closing costs on a home).
- The Variable interest rate could rise and increase your monthly payments.
- When the draw period ends, you can no longer withdraw money and use the line of credit.
- There may be annual fees or closeout fees involved.
- When you select the interest only payments, no principal is paid on the credit line.
The Pros and Cons of a Home Equity Loan
A home equity loan is another way to allow Americans to tap what is perhaps their single biggest asset: their homes. These types of equity loans are attractive because they deliver money in one lump sum payment once an application is approved.
Here are some other pros and cons of home equity loans:
Home Equity Loan Pros:
- Home equity loans can be used to pay off just about anything, including high-interest credit card debt.
- The interest on an equity loan is simple interest so it amortizing monthly rather than compounding daily like a credit card.
- Home equity loans can be locked in at fixed rates, meaning your payment period and the amount due each month will never change.
- The equity loan typically allows you to borrow around 80% to 90% of your home’s value, so if you need a large sum, it might be a good option. (If you have damaged credit you may only qualify for 70 -80% LTV and may need to apply for a home equity loan with bad credit.)
- Just like a home equity line of credit, home equity interest might be tax-deductible.
- You need to be sure you can afford the payment of your home equity loan in addition to paying your current mortgage.
- Interest rates are usually higher than a HELOC.
- Closing costs can be substantial.
- If you sell your home before you’ve paid off the loan, the balance becomes due immediately.
About the Variable Interest Rate Home Equity Line of Credit
The HELOC offers greater borrowing flexibility compared to home equity loans. With an extended draw period, you can access the specific amount of money you require precisely when it’s needed, reducing the risk of borrowing excessively.
If you know what your home is currently worth and what you still owe on your mortgage, chances are that your home has equity available to utilize. Many people choose to take advantage of that by applying for and opening a home equity line of credit, or a HELOC. The home equity lines are set up with variable interest rates.
What is a HELOC, exactly? Most experts would describe it as an exclusive or limited line of credit, much like that small piece of plastic that you have in your wallet. But the key difference of a HELOC line is that your home serves as collateral. That means if you don’t pay the money back, you default on the property. But as long as you need the money it’s there, so you can use it, pay it off, and use it again, just like a credit card.
About Fixed Rate Home Equity Loans
While home equity loans sometimes carry higher interest rates than HELOCs, they still tend to be more cost-effective than alternatives like credit cards. If you are having trouble sleeping at night because you are strapped with high-interest credit card debt, a home equity loan could provide the best solution to pay it down. Moreover, the fixed rate ensures that you won’t be affected by potential increases in home equity rates, and the federal tax deduction for interest paid is applicable to home equity loans when you are financing home improvements. Fixed interest rates ensure that you will have fixed monthly payments for the life of the mortgage.
Rest assured, a home equity loan and a HELOC are two different things. With a home equity loan, you borrow an amount of money (drawn from the equity in your home) just once and then make regular payments on that amount over a fixed amount of time.
Unlike a HELOC, a home equity loan doesn’t free up money to use again as you make payments. But like a HELOC, a home equity loan borrows against your home so you’ll want to stay current on paying it back. According to Lending Tree, most repayment periods vary between 5 and 15 years, but with interest rates slightly higher than a HELOC or your original mortgage.
A simple interest home equity loan offers distinct advantages to homeowners. Unlike a traditional home equity credit line, it charges interest on the outstanding balance daily, which means you can reduce your interest costs by making extra payments or paying off the equity loan early. This flexible structure allows you to save money in the long run. Moreover, simple interest loans typically have lower upfront closing costs, making them an economical choice for homeowners looking to tap into their home equity. Additionally, the interest paid on these loans may be tax-deductible, offering potential financial benefits.
The fixed interest rate equity loan offers financial flexibility, cost savings, and potential tax advantages for homeowners seeking money for a variety of reasons. Overall, home equity loans are said to be the preferred choice for borrowers who don’t like surprises. Apply for a home equity loan.
Frequently Asked Home Equity Questions
Many homeowners wish to compare interest rates on HELOCs and home equity loans. In fact, one of the most commonly asked questions on Google is, “What is the current interest rate on a home equity loan?” (and/or a line of credit).
National and regional lenders will offer different rates on each product, with the rate averages for home equity loans offered with a five-year, 10-year, or 15-year term. Generic rates assume the borrower likely has a certain credit score, a standard amount of equity in the home, and may put a cap on how much the homeowner wants to borrow. But remember, Individual lenders will all have their own rates and terms and you shouldn’t be afraid to shop around.
Other commonly asked questions include, “Will a HELOC hurt my credit?” and “Is a home equity loan a good idea?”
Because a home equity loan HELOC is a type of credit, an application will impact your credit score. But if you open a HELOC and don’t use all of the money available, your score might improve.
Because both HELOCs and home equity loans have advantages and disadvantages, you’ll need to decide if opening one is a “good idea” based on your situation.
Can You Convert a HELOC to a Fixed Home Equity Loan?
There are a few home equity lenders that permit the conversion of your home equity credit line into a fixed-rate equity loan. To qualify for these unique HELOC loans, it’s essential to have sufficient untapped home equity and stay within the lending sources’ specified debt-ratio limit. Additionally, one should carefully assess the potential closing costs and fees associated with these credit line option in comparison to the advantages of securing a fixed interest equity loan.
Both Equity Loans and HELOCs Can Benefit Homeowners Financially
Is a HELOC better than a home equity loan? Again, there’s no simple answer to this question and you should have a big picture view of your finances before making a decision on tapping into your home equity.
Keep in mind that both a HELOC and a home equity loan will require you to make a decision upfront about how much money you’ll need and how you’re going to use it. You should factor in all the pros and cons of the lists above as you make your decision.
No matter what, using the equity in your home is a gamble because a failure to pay means you could lose your home. If what you need is short-term funding, neither a HELOC nor a home equity loan is likely the best solution.
No matter what, be sure to do your homework, shop around, and compare HELOCs or equity loans offered by various lenders. This will help you lock in the best deal to fit your situation and meet your financial needs.