HELOC or Home Equity Loan: Which Is Right for You?

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Reviewed byTimothy Manni
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Updated: February 19, 2024

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Understanding the differences between a home equity line of credit (HELOC) and a home equity loan is essential if you're considering using your home's equity. While both allow you to borrow against your home's value, knowing how they differ is important. If you don't, you might make unsuitable choices that impact your long-term financial health.

Our page clarifies the nuances of HELOCs vs. home equity loans, guiding you through their distinct features, such as how you borrow and repay the funds. You'll learn about their benefits, requirements and factors to consider when choosing between them.

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Comparing Features of HELOCs and Home Equity Loans

HELOCs and home equity loans share key similarities, like being secured against your home equity and potentially offering tax benefits on interest. However, they have differences you must consider. A side-by-side comparison is an excellent way to do this, helping you decide which suits your needs best. Let's explore this further in the comparison table below.

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Understanding the difference between HELOCs and home equity loans can help you make a more informed financial decision. While both provide valuable options for leveraging your home's equity, the right choice depends on your specific borrowing needs and financial situation.

Requirements for a HELOC vs. Home Equity Loan

While HELOCs and home equity loans have their differences, lenders typically consider similar factors when evaluating applications for both. By knowing what these are, you can gauge your eligibility and prepare your application effectively. Being aware of what lenders look for can also guide you in strengthening your financial standing, increasing your chances of approval.

Here are the key requirements:

  • Home Equity: Lenders often require you to have at least 15% to 20% equity in your home. You can determine this by subtracting your mortgage balance from your home's current market value.

  • Income: Proof of stable and sufficient income is essential. Lenders want to make sure you have the means to make loan payments.

  • Debt-to-Income Ratio (DTI): Ideally, your DTI should be below 43%. A lower ratio indicates that you aren't excessively burdened by debt and are more likely to manage additional loan repayments effectively, making you a more attractive candidate.

  • Credit Score: A score of 700 or higher is typically preferred. Higher scores can lead to better interest rates. Regularly checking and improving your credit score can be beneficial.

  • Appraisal: An appraisal is often required to determine your home's current market value, which affects the amount you can borrow. A professional appraiser will evaluate various factors, including your home's location, size, condition and recent improvements, as well as the selling prices of similar homes in your area.

Understanding these requirements will help you assess your readiness for a HELOC or home equity loan. It also gives you the opportunity to improve your financial standing and enhance your chances of approval. Remember, thorough preparation is key to a successful application.

What Is a HELOC?

A home equity line of credit (HELOC) is a flexible financial tool for homeowners. It works as a revolving line of credit, allowing you to borrow against your home's equity whenever needed. How does a HELOC work? It has two phases: the draw period, where you can access funds, and the repayment period, where you pay back what you've borrowed. HELOCs usually have variable interest rates, so your payments can fluctuate over time, depending on market changes. It's best to consider this as it will impact your monthly budgeting.

HOW MUCH HOME EQUITY DO YOU HAVE?

To calculate home equity, first, find out your current home value through an appraisal or by looking at recent sales of similar homes in your area. Then, subtract the amount you still owe on your mortgage from this value.

For example, if your home is valued at $300,000 and you owe $200,000, your home equity is $100,000. Knowing your home equity is important as it determines how much you can borrow through a HELOC or home equity loan. Remember, more equity usually means more borrowing power.

Pros and Cons of a HELOC

HELOCs are a flexible option for accessing funds; they can have low interest rates and potentially cheaper borrowing costs. However, focusing only on positives can be misleading. It's best to have a balanced view, understanding both sides of the coin. For instance, the variable interest rate of a HELOC, while beneficial in a low-rate environment, can also lead to increased payments if it rises.

Let's break down these aspects in detail:

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Understanding the pros and cons of a HELOC is essential. A balanced perspective will help you decide whether a HELOC is right for your financial situation.

What Is a Home Equity Loan?

A home equity loan offers a way for homeowners to borrow against the value of their homes. Unlike HELOCs, they provide a one-time lump sum, making it ideal for large, specific expenses. Home equity loans have fixed interest rates and straightforward payment structures. That means your monthly payments stay the same throughout the loan term, each covering both interest and principal. Understanding the features of this option can help you manage significant financial needs more effectively.

Pros and Cons of a Home Equity Loan

A home equity loan can be a solid option for those needing a substantial amount of money, offering benefits like predictable monthly payments. However, it's essential to balance these with the potential risks. For instance, securing the loan against your home means if you can't keep up with repayments, there's a risk of losing your property. These advantages and drawbacks are important considerations for making a well-informed decision.

Let's dive deeper into the pros and cons:

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Weighing the pros and cons of a home equity loan is essential. Understanding both aspects will help you make choices aligned with your financial situation and goals.

HELOC vs. Home Equity Loan: Which Is Better for You?

While TranUnion’s Credit Industry Insight Report for Q4 of 2023 shows that both HELOC and home equity loan originations have decreased, they remain viable financial solutions for most homeowners. However, one might be more suitable for your specific situation than the other. Making the wrong choice could result in financial strain, such as struggling with unexpected payment increases or borrowing more than necessary.

Carefully considering various factors can guide you in determining the most suitable option:

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When comparing HELOCs and home equity loans to determine which is better, it ultimately depends on your specific financial needs, preferences and circumstances. With these factors, you can make an informed choice that aligns with your financial goals and offers the most benefit for your situation.

MONEYGEEK EXPERT TIP

Sometimes, it's easy to think, "I only need my home equity funds for one thing, so a home equity loan is the right choice for me." But if you work with a lender to determine a range of monthly payments you can be comfortable with, choosing the flexibility of a line of credit allows you to access cash now and in the future. That's a long-term financial safety net you may have yet to realize you needed. Just make sure you properly plan for the adjusting interest rate and remain diligent about what you spend the funds on. — Timothy Manni, Mortgage and Real Estate Consultant

Common Uses for HELOCs vs. Home Equity Loans

HELOCs and home equity loans can both be used for similar purposes, like home renovations or consolidating high-interest debt. However, the specific circumstances of your financial need often play a crucial role in determining which option is more suitable. Our table provides more details regarding the nuances of each and can guide you in choosing the one that aligns best with your situation.

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A HELOC might be preferable for ongoing projects where costs are spread out over time, while a home equity loan could be more fitting for a one-time, considerable expense with a known cost upfront. It's about matching the flexibility and structure of the loan to the nature of your financial needs.

FAQ: HELOC vs. Home Equity Loan

Whether you're deciding which option to choose, wondering about borrowing limits or curious about the approval process, our answers to common questions about HELOCs and home equity loans can shed light on the key aspects of both financial products.

A HELOC is a revolving line of credit with a variable interest rate that offers flexible borrowing and repayment options. In contrast, a home equity loan provides a lump sum with a fixed interest rate and fixed monthly payments.

Yes, it's possible to have both a HELOC and a home equity loan simultaneously, as long as you have sufficient equity in your home and meet the lender's criteria for both loans.

The borrowing limit for both a HELOC and a home equity loan typically depends on how much equity you have, your income and your creditworthiness. Usually, you can borrow up to 85% of your home's equity minus your outstanding mortgage balance.

While it's more challenging, obtaining a HELOC or home equity loan with bad credit is possible. Lenders may require a higher equity percentage and offer higher interest rates to offset the risk.

Interest rates for both are influenced by the market rates, your credit score, loan-to-value ratio and your home's equity. HELOCs typically have variable rates, while home equity loans usually have fixed rates.

Yes, both HELOCs and home equity loans may have closing costs, including appraisal, application and attorney fees. These costs vary by lender and the specifics of the loan.

For a HELOC, you usually make interest-only payments during the draw period, followed by principal and interest payments during the repayment period. Home equity loans require fixed monthly principal and interest payments from the beginning.

Yes, both HELOCs and home equity loans can be refinanced. You might consider doing this to secure a lower interest rate, adjust your monthly payments or consolidate debts.

The interest on HELOCs and home equity loans may be tax-deductible if the funds are used for home improvements. It’s best to consult a tax advisor for your specific situation.

It may take a few weeks to a couple of months for a HELOC or a home equity loan application to be approved. The exact timeline depends on the lender and your personal financial situation.

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