Understanding the Differences Between HELOC and Home Equity Loan

Making a decision about how to finance major purchases or repairs is an important one. HELOC vs. Home Equity Loan is different although both can provide financing. 

Borrowing money against the equity in your house can be done in a number of ways, the most common of which are home equity loans and home equity lines of credit (HELOCs). The difference between a home equity line of credit (HELOC) and a home equity loan is the interest rate on the loan.

While home equity loans are best for large, one-time purchases, home equity lines of credit can help with smaller, recurring payments. Home equity lines of credit (HELOCs) and home equity loans (HELOCs) are additional types of second mortgages.

But to decide which one is right for you, you need to understand the differences between HELOC vs. Home Equity Loan. This article will discuss what HELOC vs. Home Equity Loan is, how they differ and how to decide which one is right for you.

What is a Home Equity Loan?

When you take out a home equity loan, you are essentially taking out a second mortgage against the value you have built up in your property. Up to 85% of your home’s worth (less the mortgage balance) is often available as a loan amount.

To determine how much equity you have in your house, subtract your mortgage or other debts from the property’s current market value. Your equity would be $50,000 if your home’s value was $250,000 and your mortgage was $200,000. 

Loan amounts up to eighty or ninety percent of the home’s worth (less any outstanding debts) are typically approved. Collateral, on the other hand, involves putting up one’s own property as security for the lender in case of loan failure.

When you have a home equity loan, you get one lump sum of cash from the lender, which you repay with interest over a set period of time. The interest rate and repayment plan will be based on your credit score and income, and the loan can be used for almost any purpose, like consolidating debt or paying for home repairs and improvements.

A HELOC differs from a home equity loan in that the interest rate fluctuates over time, along with the borrower’s monthly payments. There are HELOCs that offer low introductory rates for a set period of time (say, six months), but then switch to a higher, yet variable rate after that.

What is a HELOC?

A HELOC is a home equity line of credit. This is an open-ended loan that allows you to borrow money when you need it, up to a certain limit. The limit is set depending on the amount of equity you have in your home. The lender sets a percentage of the home’s value (usually from 80-90%) minus what is owed on the mortgage, and that’s the limit of your HELOC.

The initial “draw” period is followed by the “repayment” period. Once you enter what is called “the draw period,” you can begin making withdrawals from your line of credit. The only payment due throughout the draw term is interest on the amount borrowed. 

At the conclusion of your draw period, you’ll be responsible for making principal and interest payments. The interest on a home equity line of credit (HELOC) typically varies with market conditions.

Once you have the HELOC, you can draw from it whenever you need cash. Also, as often as you need it. You only pay interest on the amount you borrow and you can repay it as you’re able. 

Some lenders require you to make monthly payments, no matter how much you’ve borrowed. Others may charge a minimum monthly payment, but you only pay interest on what you’ve drawn.

The Differences Between a HELOC and a Home Equity Loan

Compare HELOC vs. Home Equity Loan and see what the differences are. Payments, interest rates, and the distinction between installment and revolving credit all vary.

The major difference between a HELOC vs. Home Equity Loan is that a HELOC is open-ended while a home equity loan is a lump sum payment. That means that with a HELOC, you can draw from the amount you have been eligible for as often as you need it up to the specific limit. 

With a home equity loan, you get a lump sum and have to repay it in equal installments over a specified period of time. Furthermore, the interest rate for a home equity loan is often absolute. No matter how long it takes to pay off the loan, the interest rate will remain unchanged. 

In the case of a loan with an interest rate of 5%, for instance, you would continue to make payments equal to that rate until the loan was repaid in full. The rate on a HELOC, on the other hand, is typically not standard. This is a type of interest rate that changes in relation to some fixed or variable benchmark.

However, if you don’t pay off your revolving credit card balance in full each month, the remaining balance will roll over into the next billing cycle. We refer to this as a revolving balance. Credit cards, personal lines of credit, and home equity lines of credit are all examples of revolving credit accounts.

Another major difference between a HELOC vs. Home Equity Loan is payment terms. With a HELOC, you usually only pay interest on what you borrow and can pay off the balance whenever you want. With a home equity loan, you’re responsible for regular payments of interest and principal over a certain period of time.

Conclusion

Both home equity loans and home equity lines of credit allow you to borrow money against the value of your property, but they function differently. When considering a HELOC vs. Home Equity Loan, it is important to think about both your financing needs and your appetite for uncertainty. 

While there are benefits to both, a home equity loan may be preferable if you have a clear plan for the money. Also, if you don’t require much leeway. If you’d rather have a set monthly payment and interest rate, a home equity loan may be your best option.

On the contrary, a HELOC may be preferable if you want the flexibility to borrow as much or as little as you need, whenever you need it. If you need money for a large, unpredictable expense like college tuition but don’t want to pay for it until you absolutely need it. Also, if you don’t mind if your payment goes up and down occasionally.

Think about why you’re borrowing money, how much you’ll actually need, and whether you’ll want more in the future. Once you decide between HELOC vs. Home Equity Loan, the next step is to improve your credit score and comparison shop for the best interest rate. Talking to a lender about your available options is the greatest method to narrow down your decision.

FAQs

1. How much can I borrow with a HELOC or a home equity loan?

This depends on the value of your home and how much is due on it. Generally, lenders will approve loans for up to 80-90% of the home’s value, minus what is owed.

2. What can I use a HELOC or home equity loan for?

You can use a HELOC or home equity loan for almost any purpose. Examples are consolidating debt, making home improvements or repairs, paying for tuition, and so on.

3. Which loan is best for me, a HELOC or a home equity loan?

A HELOC may be better if you need more flexibility with borrowing and repayment. However, a home equity loan may be right for you if you need a lump sum of cash.