Home Equity Line of Credit vs Loan
Ever heard of the term “House Rich but Cash Poor.” It happens when you have money tied in equity but not in your hands.
1.42 million homeowners with outstanding mortgages have home equity built up on their homes. Accessing your equity can be helpful in times of emergency or even when you are strapped for cash.
Coming to borrowing, you can do it via a loan or a line of credit. Both of them use equity, which is the value of the home left over after accounting for the first mortgage.
This article discusses the difference between the two, benefits, drawbacks, interest rates, and everything in between.
What Is the Difference Between a Home Equity Loan and a Home Equity Line of Credit?
Often termed as second mortgages, the similarity lies in both using your home as collateral. Both the loans are quite different in the way they operate.
A home equity loan is a fixed loan that you borrow against the equity. You repay the loan in monthly payments over a previously agreed term, and the interest rate is for the entire loan.
The home equity line of credit works pretty much like a credit card. You can borrow as much as you need within limits and whenever you want. Again, repayment is monthly but only for the amount borrowed. The interest rate is variable and only for the borrowed amount.
Is a Home Equity Loan the Same as a HELOC?
No! Home equity loan is not the same as a HELOC. Even though they are borrowed against your home equity, they have distinct differences.
Equity loans have fixed monthly payments and a fixed interest rate over the life of the loan, while the latter has variable payment and variable interest rate.
Which Is Better: a Home Equity Loan vs Line of Credit?
Both HELOC and home equity loans can be good options, but every loan has its own pros and cons. It is essential that you talk to your lender about the terms beforehand.
The loan is a better choice if you:
- Need a lump sum
- Prefer a fixed rate of interest
- Favor fixed monthly payments.
You can go for a HELOC if you:
- Have the option to borrow as little or as much as your want
- Upcoming expenses like college but want to have control over when to borrow
- Do not mind the varying payments or the rate of interest.
Apart from the above, make sure you shop for better interest rates with different firms before accepting one.
Can I Have a HELOC and a Home Equity Loan?
Theoretically Yes! You can have a HELOC and a home equity loan. There are no caps on the number of loans you may hold at one point in time.
But your lender may not be so agreeable with each new application. Even if they agree, the rate of interest would be much higher the second time around, especially if it is from the same lender.
How Do You Know How Much Equity You Have in Your Home?
Home equity is the difference between the current value of your home and the loan balance. If you have more than one loan against it, the loan balance would be the sum of all debts registered against your home.
You may also want to keep an eye on the equity as it rises and falls with your home’s value. You may be able to increase it by keeping it well maintained and making calculated renovations.
What Is the Primary Benefit of a Home Equity Loan?
A home equity loan allows you to borrow a lump sum for large expenses like home improvements or consolidate your debt for a lesser interest rate.
If you use the amount for renovations, the interest may even be available for a tax deduction.
Because you borrow against your home, it might be easier to obtain than the other conventional loans.
Are Home Equity Loans Worth It?
Equity loans are worth if the amount serves a purpose like paying off high-interest loans or credit cards.
In most cases, the fixed interest rates for your home loan is lesser than a personal loan or even your credit cards.
It can also be your way out of an emergency expense or a major repair.
What Are the Disadvantages of a HELOC?
As with every loan, the home equity line of credit also has a few disadvantages:
- Equities change with the value of the property. If the value goes down, the equity does too.
- HELOC has your home as collateral. If you fail to make the payments, the bank can close in and foreclose the property.
- You still have to make payments. So, if you max out your line, the credit score can take a hit.
- Some lenders charge penalties, annual fees, closing costs, etc.
- The first ten years are interest-only payments. After ten years, you have to pay the principal as well. Most do not expect the balloon payment and find themselves saddled with principal and interest payments.
- Since they have variable interest rates, they can fluctuate quite a bit.
Is it a Good Idea to Get a Line of Credit?
A line of credit is a good idea when you have a significant expense coming up, but you are unaware of the costs.
Make sure you would be able to make the payments in the future or run the risk of losing your home.
What Is the Current Interest Rate on a HELOC?
The current interest rate for a HELOC is 5.61%. Since it is more volatile, it keeps changing.
Having said that, the rate for a HELOC is dependent on your:
- Loan-to-value ratio
- Debt-to-income ratio
- FICO Credit Score
A low LTV and high score may ensure a lower interest rate, but a high DTI gets a higher rate.
How Does a HELOC Work?
In a HELOC, you borrow against the equity in your home, and your home is the collateral. You can borrow as little as you like or as much as you like. You can borrow up to 85% of the existing equity.
After you repay, the credit line is replenished, and it is available back for you to borrow again.
Usually, the first ten years is the draw period, and you can withdraw up to the limit. Then starts the repayment period, which is generally 20 years.
Can You Sell Your House if You Have a Home Equity Line of Credit?
Yes! You can sell as long as you repay the line of credit in full. Since you are using your home as security, a sale isn’t possible until you repay your loan amount.
However, if the value of the home falls or if it is underwater, you may end up owing more than what your home is worth.
Do You Need an Appraisal for a HELOC?
Most lenders conduct an appraisal of their own for a HELOC. That’s a good thing because the current automation often pulls up the wrong value. But, an independent appraisal gets you a fair market value.
Meanwhile, few might also do a drive-by appraisal along with pictures to determine a value.
Is a HELOC Tax-Deductible?
Yes! Your interest on a HELOC may be tax deductible up to $750,000 as long as you use it to:
- Renovate your home
- New roof
- Remodeling kitchen or bathroom
- New driveway
The money must be used on the property, which is the source of the line.
What is the Minimum Payment on Home Equity Lines of Credit?
The minimum payment depends on the lender. Few have payments as low as $125 per month and others as much as $200.
The initial payments are towards the interest alone in the draw period. You pay back the principle only during the repayment period.
Can You Get a HELOC with Bad Credit?
Mostly Yes! But it depends on the lender. Since your home is the collateral, most lenders may offer to approve the line of credit even if it is low. But the DTI also plays an important role.
A high credit score helps with a high DTI, but if your DTI is lower, a low score doesn’t matter.
Does it Make Sense to Get Home Equity Loans?
It makes sense to take home equity loans as long as you use the money brings you some value in return, like a substantial home improvement. It also makes sense to spend it on educational expenses.
But make sure you’d be able to make the monthly payment on time, or you could lose your home.
How Do Home Equity Lines of Credit Differ from Personal Lines of Credit?
Personal lines of credit are similar to a credit card where you are given a credit limit within which you can borrow as much as you’d like. The payment depends on the amount you borrow, and the interest rate is much lower than a conventional credit card.
Equity lines of credit are on the same page as the personal line, but they are borrowed against your home’s equity. You can avail of a HELOC only if you have equity in your home. They have variable interest rates, which are much lower than that of the former.
What Is Better: HELOC or Personal Loan?
With a personal loan, you get a lump sum much like the home equity loans with a fixed rate of interest.
On the other hand, HELOCs are much like credit cards where you borrow against your home’s equity.
Even though the rates for home equity lines are lower than personal loans, they are variable and might fluctuate. And for that reason, lines are suitable when you intend on repaying in the near future. But if you are looking for some quick cash, personal loans are the best option.
Should I Take a Home Equity Loan or a Student Loan?
Home equity loan interest rates are lower than the student loan. The reason being the home loans have your home as the collateral.
Hence, it is better to take a home equity loan with its low rates.
Which Is Better: Cash-Out Refinance vs Home Equity Loan vs Line of Credit?
The cash-out refinance a brand new mortgage loan essentially, and hence the closing costs are higher than the home equity loans and the line of credit. But it has lower rates than home loans.
A home equity line lets you borrow in small amounts within the credit limit rather than all the cash during the draw period. In the repayment period, the money is paid back, interest and principal.
On the other hand, a home equity loan lets you borrow a large sum of money against the equity. You repay the same in monthly payments as you agreed with the lender.
Both have their own pros and cons. The home loans have a fixed rate, while the lines have a variable rate. The interests for both cases are tax-deductible but only if used for home improvement.
But if asked which one is better? The answer depends on your need.