Home Equity Loan vs HELOC: What’s the Difference?
Every month as you make your mortgage payments, you are accumulating equity in your home. Plus, if your home has gained market value since you’ve purchased it, you’ve also accumulated equity that way.
However, most of the time, you’re unable to tap into your home’s equity until you sell your home, triggering cash out of those profits.
That’s where home equity loans and lines of credit come in. These second mortgages are a way to leverage your home’s equity and get access to that capital without selling your home.
But which one is best for your financial situation? And how do they differ?
What is a Home Equity Loan?
A home equity loan is a one-time lump sum that the bank will approve you for based on your home’s equity.
Borrowers must repay a one-time amount, whether you use the full amount or not. Because of this, you should only apply for the amount you need to borrow. A home equity loan is also known as an installment loan or a second mortgage.
One of the biggest benefits of a home equity loan is that your interest rate and monthly payments will remain fixed over the course of the loan. This can make budgeting easier every month and will ensure you can factor in the same amount monthly.
A home equity loan is a great option if you want to use the line of credit to re-invest in your home through improvements or upgrades. But keep in mind that you’ll be required to repay the total amount you borrow, so it’s best used for a specific project or purpose.
What is a HELOC?
You can think of a HELOC as a credit card that uses your home’s equity as collateral. Unlike a home equity loan, a HELOC is a revolving account that you can use multiple times and borrow against when you need it.
Depending on your equity, you can borrow anywhere from 60% to 85% of the equity earned in your home. However, be aware that most of these have a variable interest rate, which means your monthly payments could change throughout your loan.
One of the biggest benefits of a HELOC is that you don’t have to use the entire amount approved, and you will only pay interest on the money you’ve actually spent.
With a HELOC, you’ll be required to make monthly payments on the amount you owe, but you will be able to use the funds over an extended period. Usually, HELOC’s are based on an adjustable rate term, but some lenders will offer fixed rate HELOC.
Make sure you speak with a trusted advisor about the best option for you and your needs.
A HELOC is a good option for homeowners who have established significant credit in their house and need a loan for multiple projects or needs. One of the most appealing things about a HELOC is that it is one of the more flexible home loan options.
You don’t necessarily have to use the funds for home improvement projects — some people even use a HELOC to pay off student loans, medical bills, or debt consolidation. Because you can use a HELOC over a long period, this type of loan is great if you have a large project that will be completed in multiple stages.
How Do You Use Home Equity?
If you’re considering using a home equity loan or HELOC, it’s important to fully understand how equity is calculated.
To calculate the amount of equity in a home, the bank might require you to get an appraisal to determine the home’s current value.
From there, your equity is the difference between what you own on the property and how much it’s appraised for. The bank will then loan you a percentage of that equity in either a lump sum (home equity loan) or in a line of credit (HELOC).
Your home’s equity is a powerful tool in your financial toolbox. Not only do you gain equity every time you make a mortgage payment — as your home increases in market value, but you will also gain equity.
It’s important to remember, though, that with either type of loan, the borrower is putting your house up as collateral. This becomes a problem if your home suddenly loses its value or you cannot make your loan payments.
Is Home Equity Loan Better than HELOC?
Both the home equity loan and the HELOC are based on one thing — your home’s line of credit. However, they both have different terms and conditions that offer pros and cons depending on your needs.
If you want the most flexible option, a HELOC is a convenient solution for a variety of expenses. From home improvement costs to an unexpected medical bill, you can utilize your HELOC at the specific time you need it.
And, since you aren’t required to use the full amount, you only will pay interest on the money you spend. Remember that a HELOC will likely come with an adjustable interest rate, meaning your monthly payments will fluctuate over the course of the loan.
If you have a specific project in mind or know exactly how much money you need, a home equity loan is probably a better fit for you. With a lump sum payment, your interest rate and monthly payments will remain the same.
One of the negatives of a home equity loan though is that it is just a one-time expense, and you’ll be required to repay the full amount you borrowed whether you use all the funds or not.
Final Thoughts Home Equity Loan vs HELOC
Whether you’re considering a home equity loan or a HELOC, you should speak with a trusted real estate or mortgage advisor beforehand.
While they’re a great option if you need access to your home’s equity, they also can carry significant consequences if misused — including losing your house.
With the proper guidance and advice, though, they can be a great addition to your financial portfolio!
TL;DR: A home equity loan is a one-time sum of money loaned to the homeowner whereas a HELOC is a continual amount of money that is being borrowed, like a credit card.