Looking to tap into your home’s equity to help fund an improvement, renovation, pay for college or consolidate debt?
As a homeowner, you have options, two of the most common being home equity loans and HELOCs.
A home equity loan is a lump sum loan that borrows money using the equity in your home as collateral. In contrast, a HELOC, or “home equity line of credit,” allows you to borrow money against the equity of your home on more of an on-demand basis.
Understanding Home Equity Financing Options
What is a Home Equity Loan?
A home equity loan is similar to any type of loan. When you’re approved for a home equity loan, you’ll receive a lump sum of money and pay it back monthly with interest. The big difference is that home equity loans use the equity in your home as collateral, so if you become unable to pay back the loan, the lender could foreclose on your property. Because of this, many people think of home equity loans as second mortgages.
Such loans are often sought for home improvements and renovation projects, to consolidate debt, pay for a child’s college or make an expensive purchase (i.e., a vehicle, boat, etc.).
What is a Home Equity Line of Credit (HELOC)?
HELOCs are similar to home equity loans in that you’re borrowing against the equity of your home, but they offer more flexibility. One key difference is that HELOCs work as more of a line of credit, meaning you can borrow money on an as-needed basis. Think of a HELOC similar to how you would use a credit card. You’ll be approved to borrow a certain percentage of your home’s equity and then can borrow the money as you need it and when you need it. You’ll only repay and pay interest on what you borrow. HELOC interest rates tend to be variable.
HELOC funds can be used to pay for the same things a home equity loan does.
Key Differences Between HELOCs and Home Equity Loans
There are several key differences to note between HELOCs and home equity loans. These include:
- Interest rates: Home equity loans tend to have fixed interest rates, while HELOCs often have variable interest rates.
- Fund disbursement: You’ll receive a lump sum of money when you’re approved for a home equity loan. HELOCs provide a credit line, allowing homeowners to borrow against it as needed.
- Repayment: Expect fixed monthly payments with home equity loans. Conversely, HELOC’s offer various repayment programs such as interest-only repayments for specified periods of time.
Pros and Cons of Home Equity Loans
Like anything, home equity loans have their share of pros and cons. Here’s a closer look at some of them:
Pros
- Fixed interest rates offer more predictable payments, allowing borrowers more budget certainty.
- They’re ideal for large, one-time qualifying expenses.
Cons
- There’s little flexibility. Home equity loans are lump sum amounts, and they all must be repaid with interest.
- There’s considerable risk if you’re unable to repay the loan, as you are using your home as collateral.
Pros and Cons of HELOCs
Some pros and cons of HELOCs include:
Pros
- There’s more flexibility compared to a home equity loan. You can borrow as much or as little as you need from your line of credit — and you can borrow multiple times.
- You only pay interest on the amount that you borrow, not the total amount that you were approved for.
Cons
- HELOCs often have variable interest rates, which may bring more uncertainty with repayment amounts.
- Similar to using a credit card, there’s always the risk of over-borrowing due to how easy funds are to access.
Factors to Consider When Choosing Between a HELOC and a Home Equity Loan
Home equity loan or HELOC? If you’re deciding between the two options, there are several factors you’ll want to weigh. These factors include:
- What you’re using the funds for: Do you need a lump sum to fund some sort of expense or purchase or do you expect to require access to money for ongoing expenses? If the former, a home equity loan is probably best. If you’re in the latter scenario, a HELOC might be best.
- Interest Rate Flexibility: One of the nice things about home equity loans is that they come with fixed interest rates, so you have repayment certainty. It can be beneficial to lock in a low fixed rate. HELOCs often come with variable interest rates, so your repayment amount may fluctuate based on market conditions.
- How you prefer to repay: Do you prefer to pay a fixed amount each month or do you have the budget to support a variable interest rate?
Potential Risks and Considerations
Both HELOCs and home equity loans have their fair share of risks, especially when you borrow against the equity in your home. For instance, in both cases, your home is essentially being used as collateral. If you were to fall on hard times and be unable to pay the loan back, you could lose your home.
Additionally, there are market conditions to consider with each loan. Fluctuations in the housing market can impact your home’s equity, thereby influencing how much you’re able to borrow against your home.
Recent Trends in Home Equity Financing
Home equity financing options are popular options for homeowners because it’s an easy and convenient way to borrow money. Moreover, it’s estimated that more than half of all mortgage holders are “equity rich,” meaning their mortgage value is at least equal to half of their home’s market value.
Additionally, home equity borrowing is rising thanks to more relaxed credit requirements from most lenders. Noting this, even homeowners with poor or average credit may be approved for home equity loans or HELOCs.
How to Apply for a HELOC or Home Equity Loan
Once you’ve decided on either a HELOC or home equity loan, the next step is to go through the application process. Here’s a look at the steps you’ll take with a lender to get approved:
- Eligibility requirements: The first thing your lender will do is ensure you’re eligible for a HELOC or home equity loan. They’ll run a credit check, verify your income and assess your property for how much you can borrow against it. Your mortgage balance will also be taken into consideration when determining your eligibility and loan amount.
- Home appraisal: The process may also include getting a home appraisal to help determine how much your home is worth and how much equity you have.
- Documentation: Next, you’ll need to provide documentation. This may include bank statements, pay stubs, W-2’s, and other documents related to your assets and expenses.
- Approval: The lender will take into account your status as a borrower to determine approval.
Alternatives to HELOCs and Home Equity Loans
Don’t think either a HELOC or home equity loan is right for you? Or just want to explore other options that might make more sense for your situation? There are alternatives to consider.
Two popular alternatives to HELOCs and home equity loans are cash-out refinancing and personal loans.
Cash-out refinancing essentially replaces your existing mortgage with a larger one. You’ll then use the new, larger mortgage to pay off your current mortgage and keep the remaining amount in cash. With a cash-out refinance, you’ll pay a larger mortgage, which might have a different interest rate and term from your previous one.
Personal loans are unsecured loans that don’t involve using your home as collateral. They’re typically paid back in fixed monthly payments.
Making the Right Choice for Your Financial Goals
Home equity loans and HELOCs represent two viable — albeit different — paths to paying for a large home improvement project, college, a major purchase or consolidating debt. Home equity loans involve awarding borrowers a lump sum of money to use, while HELOCs award a line of credit and allow property owners to take as much as they need up to their approved limit when they need it.
However, there are other key differences between HELOCs and home equity loans, namely that HELOC’s have variable interest rates and the home equity loans have fixed interest rates. Make sure that you fully understand these two home equity options and your financial situation so you can make the best decision.
Take the Next Step with Island Federal
For more information on HELOC and home equity loan options, contact Island Federal today. As a leader in banking services for Long Island community members, Island Federal is committed to providing competitive rates and personalized service. Contact us today to learn more about Island Federal’s offerings – including home equity loans and HELOCs – and to schedule a consultation.
FAQs
What is the main difference between a HELOC and a home equity loan?
A home equity loan is a lump sum loan that borrows money against the equity in your, while a HELOC allows you to borrow money against the equity of your home on more of an on-demand basis.
How do interest rates differ between HELOCs and home equity loans?
Home equity loans tend to have fixed interest rates, while HELOCs often have variable interest rates.
Can I use a HELOC for home improvements?
Yes, HELOCs can be used to pay for home improvement and renovation projects.
What happens if I don’t use all the funds in a HELOC?
With HELOCs, borrowers only need to pay back what they spend. For example, if the credit limit on your home equity line of credit is $100,000 and you only take out and spend $35,000, you’ll only have to pay back the $35,000.
Are there tax advantages to using a HELOC or home equity loan?
Yes — in some situations, you may be able to deduct the interest paid on your taxes, making it tax deductible. Consult with your accountant or tax planner to learn more about whether you qualify.
How do I qualify for a HELOC or home equity loan?
You’ll have to meet certain requirements. The most important qualification is having sufficient equity in your home. It’s also important to have a good credit score — both for approval and for earning a low interest rate.