HELOCs and home equity loans let you borrow against your home’s equity to finance large expenses. Your equity is how much your home is worth minus your mortgage.
A HELOC covers ongoing expenses, while a home equity loan covers one-time expenses. HELOCs and home equity loans are examples of second mortgages, loans secured by your house.
Find out whether you should go for a home equity loan or a home equity line of credit (HELOC).
Why Do Home Equity Loans Work?
The amount you borrow will be based on a portion of your equity, not the entire amount.
A lender typically allows 80% to 85% of your equity to be borrowed. Lenders can approve home equity loans of up to $68,000 with equity of $80,000.
You’ll receive a lump sum and then make monthly payments over five to 20 years, sometimes up to 30 years, if your loan is approved.
Your monthly payment and interest rate are fixed on a home equity loan, providing predictability and keeping you from adding more to your loan.
Pros of Home Equity Loans:
- Get a fixed interest rate lump-sum payment.
- Make a fixed payment each month for a set period.
- A 30-year repayment term can be selected for affordable monthly payments, or a shorter term can be selected if you’d like to pay off debt more quickly.
- With a home equity loan, you can borrow at lower interest rates than with a personal loan or credit card.
Cons of Home Equity Loans:
- A second mortgage will be required in addition to the primary mortgage.
- In the event that you stop making payments on your home equity loan, you could lose your home to foreclosure.
- Due to the fixed rate, a home equity loan may have a higher interest rate than a HELOC.
- If property values decline, you may be forced to tap too much equity at once.
- Other fees and closing costs may be required.
How do HELOCs Work?
HELOCs are revolving lines of credit like credit cards. Throughout the term, you can borrow as much or as little as you need, paying interest only on what you borrow.
HELOCs allow you to borrow up to 85% of the equity in your home. HELOCs, however, have variable interest rates, which means that they fluctuate periodically.
Pros of HELOCs:
- Get access to funds repeatedly without having to reapply.
- Whenever you need money, borrow exactly what you need. Only pay back what you borrowed, plus interest.
- If you use a qualified HELOC to renovate your home, you can deduct the interest.
- Provide flexible payoff options, including converting some of your balance to a fixed rate.
Cons of HELOCs:
- Interest charges and loan payments can fluctuate.
- Some people may overspend if they have access to a credit line.
- If you cannot make your mortgage payments, you may lose your home since it is collateral for the loan.
Choosing Between a HELOC and a Home Equity Loan
Your decision may boil down to whether you value predictability or flexibility more.
When to get a home equity loan:
- You know exactly how much you need.
- You know exactly when the loan will be repaid and what your monthly payment will be.
- A lump sum payment is more convenient for you.
- Your credit score is good enough for a home equity loan.
When is HELOC the right choice:
- If you wish to borrow up to your credit limit, you can do so until the draw period expires.
- Despite not knowing the exact amount, there will be long-term expenses like tuition.
- Low-interest rates are your top priority. HELOCs tend to have lower interest rates than home equity loans.
- Your credit profile is strong.
- Your variable interest rate is predictable, and you can afford the increase.
Understanding home equity loans and how they can help you minimize delays and speed up your funding process. See how long home equity loans take and what may slow them down.