Difference Between HELOC And Home Equity Loan

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What is the difference between a HELOC and a home equity loan?

Financial institutions often offer both HELOCs (home equity line of credit) and Home Equity Loans. Both let you borrow against your equity (the appraised worth of your home minus what you owe on your mortgage loan), supplying you lower interest cash when you need it. But, what is the difference between a HELOC and a home equity loan, and what is the best equity loan product for you?

In this article we will look at the following:

  • What is equity?
  • What is a HELOC (home equity line of credit) and a home equity loan?
  • The Difference Between A HELOC And Home Equity Loan
  • How Do You Get a HELOC or a Home Equity Loan?

Let’s take a look at the distinctions between a HELOC and a home equity loan. This will start to build a better picture of what these home equity loan products are and if they’re right for you. Let’s say you have earned substantial equity in your home by paying down your mortgage. If your home is worth more than the remaining balance on your mortgage, you may be able to utilize a portion of your equity to fund home improvement projects, pay for unexpected expenses, or consolidate high-interest debt.

Most institutions offer two services related to utilizing the equity in your home – a HELOC (home equity line of credit) or a home equity loan. While a home equity line of credit and home equity loans are two similar home equity financial products, understanding how each function will help you decide which home equity product will best fit your needs.

What is Equity?

Equity is simply the difference between the value of your home and the amount you owe on your mortgage. For example, If your home is worth $250,000, and you have a $50,000 loan balance remaining on your mortgage, your equity would be around $200,000.

Home Value – Remaining Mortgage Balance = Equity
$250,000$50,000$200,000

What is a Home Equity Line of Credit (HELOC)

The HELOC is a type of credit that revolves much like credit cards – and is a great option for big expenditures, unexpected costs, and home renovation. Like a credit card, when you pay back some or all the funds you have borrowed from the HELOC, your credit line gets replenished.

Additionally, a HELOC is a secured loan that you borrow against the equity constructed in your home. In general, lenders let you borrow anywhere from 80% to 100% of the equity in your home. HELOCs have a specified draw period where you can make advances. Once the draw period has ended, you enter into the repayment period. Once you enter the repayment period for the home equity line of credit, you cannot draw any more funds from the loan.

How Does a HELOC Work?

A home equity line of credit allows you to borrow continuously from a credit line. This is a good loan solution if you need to make many or small purchases. This is optimal as you only pay interest on what you have borrowed. One important aspect of a home equity line of credit (HELOC) that you do not want to miss is that a HELOC comes with an interest rate that is variable, which means the interest rate may frequently change following the market conditions.

Two important notes about HELOC interest rates:

  • Variable interest may not be favorable depending on market conditions.
  • Certain lenders might specify an amount of time when a HELOC has a fixed interest rate.

The benefits of HELOCs:

  • You only use what you need
  • Flexible repayment terms
  • Potential to raise your credit score

HELOCs come in two distinct phases: borrowing and repayment of your line of credit.

The first, known as the “draw period,” occurs when the HELOC is available to be used as needed. You are only required to make minimum payments or interest-only payments on the amount you’ve borrowed.

If you’d like to extend your draw time, you may refinance your HELOC. If not, you’ll enter the repayment phase, where you will not be able to use the credit line, and you must repay the principal as well as the interest balance.

What Is a Home Equity Loan?

A home equity loan is a fixed-rate lump-sum loan based on the available equity in your home. This makes it a great choice for major single-time expenses. If your home is appraised for $400,000, and you owe $100,000 on your primary mortgage, that’s $300,000 worth of equity in your home. The greater the equity in your home, the more you can borrow. The total amount depends on other factors like your credit score and how many other debts you owe (auto loan, credit cards, student loans, etc.).

How Does a Home Equity Loan Work?

The home equity loan operates as a mortgage loan or another installment loan. The borrower will take out the amount in a lump sum once it’s time to apply. Then, you repay it using regular monthly installments for an agreed-upon time. The majority of home equity loans have 5 to 30 years of duration with fixed interest rates. However, calculate your loan based upon the annual percentage rate (APR) that takes in fees and interest rate, not the interest rate by itself.

The benefits of home equity loans:

  • One lump-sum.
  • Fixed repayment terms
  • Fixed interest rate

Home equity loans are typically used to fund home improvements, but can also be used to consolidate high-interest debt. The interest charged in home equity loans and HELOCs is tax-deductible as long as the money is used to make significant improvements to your home.

The Difference Between A HELOC And Home Equity Loan

There are several key differences between a HELOC and a home equity loan. The main differences are in the release of the loan funds and the repayment of the loan.

HELOCHome Equity Loan
Variable Interest Ratex
Fixed Interest Ratex
Flexible Payment Termsx
Fixed Payment Termsx
Credit Linex
Lump-Sumx

Distribution

A HELOC is a source of funds you can draw upon when you require it. The lender will set the maximum amount of borrowing, which you can access the amount and as much as you require as you would with credit cards.

The home equity loan will give you the benefit of a lump sum. There is a limit to the amount you can get, and you’ll get the whole value in one single transaction.

Spending

HELOCs generally have the option of a specific time frame, or “draw period” in which you can borrow several times. To get access to the money, you’ll need to write checks, pay with the payment card connected to the loan, or transfer funds into an account in your bank.

Home equity loans provide all of the funds at once in a lump sum. If you’re paying for multiple expenses or have to pay overtime, you can save an extra amount in your bank account and then spend it whenever you need to.

Payments

If you have the help of a HELOC, you might be able for small and interest-only repayments for your debt throughout your draw time. At some point, you’ll enter the repayment period, where payment is used for the principal as well as interest. When you begin the repayment process, it is no longer possible to be able to borrow.

Home equity loans payments are divided into equal (fixed) payments over the life of the loan. The amount you pay and the interest rate are fixed and not subject to change once the loan has been filed. Your bank creates the repayment schedule, which includes the cost of the interest as well as loan repayment in each monthly installment.

Use this home equity loan calculator to compare different loan amounts and interest rates.

Interest

HELOCs have variable rates. So, if rates increase, then your borrowing costs could rise. You can reduce the interest cost by maintaining a low balance (or zero amount) of your HELOC.

When you get a home equity loan, in contrast, you pay interest on the total amount of the loan, beginning with the initial month. However, the rate of interest is generally fixed. This makes it easier to make steady, regular monthly payments. It is possible to reduce interest by repaying the loan in advance, as long as there aren’t any prepayment penalties.

How Do You Get a HELOC or Home Equity Loan?

There is a lot of available information on how to attain a HELOC or home equity loan. The rate you receive will be contingent on your credit scores, income, and loan-to-value ratio and could be different from the lowest advertised rate. The majority of financial institutions require an appraisal for your home to be able to get a HELOC or a home equity loan. This is because your house will be used as collateral for the loan.

What is needed for your Home Equity Loan application?

  • Income information – your most recent paystubs and previous two years’ W2s.
  • If you are self-employed, two years of signed Federal Income Tax Returns.
  • Insurance information – a copy of your homeowner’s insurance policy.

View more home equity loans and HELOC application information.

After you’ve submitted your application, the lender will determine whether or not to accept your application in light of factors like the loan’s term and amount as well as your credit score, the ratio of income to debt, and the ratio of loan-to-value. After you’ve been approved, you’ll receive the lump sum payment in the case of a home equity loan, or draw money out of the credit line when you get a HELOC.

What is the Best Home Equity Loan Product for Me?

If you’re trying to decide between two options, a HELOC or a home equity loan, the first step is to look at your budget to determine what you can afford. It’s not something you should take without looking at different loan options, as failing to make payments or owing the loan can result in being forced to sell your property. If you’re considering taking out a loan for an unnecessary purchase, you should consider saving all or a small portion of the purchase to minimize the amount of credit you’ll be taking on.

If you’re ready to take out a loan, get in touch with one of our home equity loan specialists to determine your options.

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