HELOC Vs. Home Equity Loan: Which Is Best For You?
Melissa Brock6-minute read
September 08, 2022
What's the difference between a HELOC and a home equity loan?
As a current homeowner, you may want to undertake a home renovation project or you might need cash for another financial goal. You may be hesitant to do a cash-out refinance, which is a refinance where you trade in your old mortgage for a new mortgage and receive cash back.
Let's take a look at a home equity loan vs. a HELOC (home equity line of credit)and discuss the pros and cons (and more) to help you decide which makes better sense for you.
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Home Equity Loan Vs. HELOC: What Are They?
The main difference between a home equity loan and a HELOC is that in a home equity loan, you get an upfront lump sum that you repay in fixed payments, whereas a HELOC lets you tap into equity as needed up to a certain limit. HELOCs typically have a variable interest rate (one that changes) versus fixed rates, which are typical in a home equity loan.
Home Equity Loan
Home equity loans are a second mortgage that allow you to use the equity in your home as collateral to borrow money. Collateral means that you use your home as security to protect the lender if you end up defaulting on your loan. Your lender loans money to you as a lump sum at a fixed interest rate. You make your monthly payments during a repayment period.
You can generally borrow around 80% to 85% of the value of your home, minus what you owe on your mortgage.
Home Equity Line Of Credit (HELOC)
Let's take a look at how HELOCs work.
A HELOC is a type of second mortgage that allows you to borrow money against the equity in your home as a line of credit. You can use the equity in your home to pay for whatever you need, such as home improvements, education and consolidating credit card debt.
There are two phases: the draw period and the repayment period. The draw period means that your line of credit is open and available for you to use. During the draw period, the only payments you are required to make are interest payments on any money borrowed. Once you reach the end of your draw period, you'll have to make repayments based on your principal and remaining interest. Most HELOCs have variable interest rates, which means that they fluctuate based on the changes in the market.
Pros And Cons Of HELOCs Vs. Home Equity Loans At A Glance
Let's take a look at the pros and cons of HELOCs and home equity loans.
Don’t pay unless you use the money
Like credit cards, easy to spend more than planned
Lower initial rate, then variable
Variable rates on HELOCs can make debt grow rapidly
Easier and less costly to get
Can lose your home if you don’t repay
Home Equity Loans
Repayment begins immediately
Higher closing costs
Lower closing costs than a refinance
Can lose your home if you don’t repay
Home Equity Loan Vs. Line Of Credit: Similarities
Let's take a quick look at the similarities of home equity loans and lines of credit.
Both Are Secured Loans
Both types of loans, home equity loans and HELOCs, are secured loans, but what are the differences between secured and unsecured loans?
Secured loans are backed by collateral, as mentioned earlier. Secured loans can result in the loss of your home in the case of foreclosure.
Unsecured loans, on the other hand, don't require collateral. In other words, your lender cannot take away your home if you have an unsecured loan. It's a higher risk to lenders and in exchange, can also carry a higher interest rate. A good example of an unsecured loan is a personal loan, which doesn't require collateral.
Both Come With Closing Costs
Both of these loans are types of mortgage loans that come with closing costs. Closing costs are the charges to pay your lender when you close on a loan.
Home Equity Line Of Credit Vs. Loan: Differences
Let's also take a look at the differences between a HELOC and a home equity loan. A couple differences include fixed and variable interest rates as well as installment versus revolving debt.
Fixed Vs. Variable Rate Loans
There are two different types of interest structures among HELOCs vs home equity loans.
- Fixed interest rate: A fixed interest rate doesn't change during repayment. For example, if you have a 5% interest rate, in repayment, you'll pay that same interest until the loan is paid off. A home equity loan almost always keeps the same interest rate.
- Variable interest rate: A variable interest rate is an interest rate that fluctuates based on an underlying benchmark index or interest rate. A HELOC usually has a variable interest rate.
Installment Vs. Revolving Debt
What is an installment loan? It is a type of loan that you repay over time with regularly scheduled payments – in installments. A home equity loan is an example of an installment loan.
Revolving debt, on the other hand, is open-ended, which means that if you don’t pay the balance on your revolving credit account in full every month, the unpaid portion carries over into the next month. This is called a revolving balance. Some revolving credit accounts include credit cards, a personal line of credit and a HELOC.
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Getting A Home Equity Loan Vs. Securing A Line Of Credit
Let's take a look at the process of getting a home equity loan and securing a line of credit, from the application process, credit requirements, closing costs and appraisal requirements.
In order to get a home equity loan, your lender will take a look at your equity, credit score and debt-to-income ratio (DTI).
- Equity: Home equity refers to the portion of your home that you actually own – the difference between what your home is worth and the amount you still owe your lender. As you continue to make payments on your loan, you build equity on your mortgage.
- Credit score: Your credit score is a three-digit number that spells out how well you've handled debt in the past. Your credit score can range between 300 and 850.
- Debt-to-income ratio (DTI): Your lender will take a look at your DTI, which is your fixed monthly debt divided by your gross monthly income, turned into a percentage.
The new home equity loan option through Rocket MortgageⓇ allows you to access $45,000 – $350,000 of your home’s equity in 10- or 20-year term, fixed-rate loans. Note that Rocket Mortgage does not offer HELOCs at this time.
What are the credit requirements for home equity loans? Shoot for a credit score of 620 or higher for a home equity loan. You can also shoot for a credit score above the mid-600s for a HELOC, but an ideal credit score is above 700.
You will pay closing costs for both HELOCs and home equity loans, though home equity loans are often higher. Closing costs pay for your application fee, title search, attorney fees and other fees.
Closing costs depend on where you live and your exact loan type. Ask your lender for more information about how much you'll spend on closing costs.
What is an appraisal as mentioned in the closing costs, above? A home appraisal refers to when a real estate appraiser determines the fair market value of your home.
The appraisal processes for a HELOC or home equity loan are similar because it's likely you won't have to undergo a full appraisal. It may be done with a computer instead.
Line Of Credit Vs. Home Equity Loan: Which Is Right For Me?
Which is right for you, a line of credit vs a home equity loan?
Home Equity Loan
If you need a large sum of cash to cover an emergency, for education or another need and prefer a fixed monthly payment after you borrow, a home equity loan may make sense for you.
If you prefer borrowing cash on a revolving basis, a HELOC could work well for you. The HELOC could be great for DIYers or real estate investors who flip houses because you'll have access to money when you need it but don't have to pay for the loan until you actually use it.
The Bottom Line: Keep Your Mortgage But Tap Your Home Equity
As mortgage rates rise, homeowners can keep their current low interest rate home loans but still access the money tied up in their home.
A home equity loan gives you an upfront lump sum that you repay in fixed payments with a fixed interest rate. A HELOC lets you tap into equity as needed up to a certain limit. HELOCs typically have a variable interest rate. Think through the right home equity option for your particular situation. Your lender can also help you decide.
Apply online now for a home equity loan with Rocket Mortgage.
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