HELOC vs. Home Equity Loan: Pros and Cons

A Home Equity Line of Credit, often abbreviated as HELOC, is a financial product that allows homeowners to access a line of credit using the equity they have built up in their homes as collateral. It is a type of second mortgage, with the primary mortgage being the first lien on the property. Have you had to decide between a HELOC and a home equity loan?

Home Equity Loan, allows homeowners to borrow a fixed sum of money using the equity they have built up in their homes as collateral. Both allow you to borrow money using your home as collateral. Each has distinct differences and comes with its own sets of pros and cons.

Let’s take a look at a home equity loan versus a HELOC and discuss the pros and cons (and more) to help you decide which makes better sense for you

Home Equity Line of Credit (HELOC)

Pros:

HELOCs function like a revolving line of credit, similar to a credit card. You can borrow money, repay it, and borrow again, which provides flexibility for ongoing expenses or projects.
HELOCs often have lower upfront costs than home equity loans. This makes them more affordable to set up.
Variable Interest Rates, can be a downside, if interest rates decrease, your borrowing costs may go down.
With a HELOC, you have the ability to draw funds as needed over an extended period, up to a predetermined credit limit
In many cases, the interest on a HELOC may be tax-deductible, depending on how you use the funds and the current tax law

Cons:

Variable interest rates can be advantage in some cases, it can also lead to higher interest costs if rates rise.
The revolving nature of HELOCs can tempt borrowers to accumulate more debt than they can handle.
Can lose your home if you don’t repay

Home Equity Loan

Pros:

Fixed interest rates, which means your monthly payments are predictable.
You receive a one-time lump sum of money, which can be useful for specific expenses or debt consolidation.
Home equity loans have a structured repayment schedule, making it easier to budget and plan for repayments.

Cons:

Rising interest rates can increase your payment.
Can lose your home if you don’t repay

How To Obtain A HELOC and a Home Equity Loan

Let’s take a look at the process of getting a home equity loan and securing a line of credit, from the application process, credit requirements, closing costs and appraisal requirements.

1. Evaluate Your Financial Situation

Determine your home’s current market value and calculate your equity. Equity is the difference between your home’s value and your outstanding mortgage balance.
Assess your financial needs and goals to determine the amount you want to borrow.

2. Research Lenders

Compare different lenders, including banks, credit unions, and online lenders. Look for those offering competitive interest rates and terms.
Consider seeking recommendations from friends, family, or financial advisors.

3. Application Process

Know Your Equity: Home equity refers to the portion of your home that you actually own.
Credit score: Your credit score is a three-digit number that spells out how well you’ve handled debt in the past. Your credit score can range between 300 and 850.
Debt-to-income ratio (DTI): Your lender will take a look at your DTI, which is your fixed monthly debt divided by your gross monthly income, turned into a percentage.

4. Undergo a Property Appraisal

The lender may require an appraisal to determine the current market value of your home.

5. Credit Requirements

Obtain your credit report to ensure it’s accurate and to understand your creditworthiness. A good credit score will help you qualify for better terms.
Shoot for a credit score of 620 or higher for a home equity loan.

6. Closing Costs

Closing costs pay for your application fee, title search, attorney fees and other fees.
Closing costs depend on where you live and your exact loan type. Ask your lender for more information about how much you’ll spend on closing costs.

7. Receive Loan Terms and Close

If approved, the lender will provide you with the terms of the loan, including the interest rate, loan amount, and repayment schedule.
Review the loan terms, including interest rates, repayment schedules, and any associated fees.
If you agree with the terms, you can accept the offer by signing the loan agreement.
The lender will complete the closing process, which may involve signing legal documents and paying any closing costs or fees.

Closing

Ultimately, the choice between a HELOC and a home equity loan depends on your financial goals and personal preferences. A home equity loan gives you an upfront lump sum that you repay in fixed payments with a fixed interest rate. A HELOC lets you tap into equity as needed up to a certain limit.

Keep in mind that using your home as collateral carries risks, as failure to make payments could result in the loss of your home through foreclosure.