Home Equity Loan vs Home Equity Line
Published on: January 4, 2025
Home Equity Loan vs Home Equity Line Of Credit: Pros and Cons
What are the possible options if you want to consolidate your debt, finance a home renovation, or need money for education? One common option that most homeowners choose is using their home equity to borrow money. However, the next thing they have to decide is whether they should turn to HELOC or HEL.
What are HEL and HELOC? What are their pros and cons? Which one is better? Let’s find the answers in the text to follow.
What is a Home Equity Loan (HEL), and How Does it Work?
A home equity loan is a type of loan where you borrow money based on the value of your home. You apply for a specific amount, and if approved, you receive the full amount in a lump sum. The loan has a fixed interest rate and fixed monthly payments. The payments remain the same during the loan period. It is sometimes called a home equity installment loan or an equity loan.
· How to Qualify for a HEL
First, you need enough equity in your home. Equity is the value you own in your home after subtracting what you owe. Lenders use methods like the combined loan-to-value (CLTV) ratio to check your equity. Normally, you are allowed to borrow up to 80% of your home’s equity.
· Interest Rate and Payments
A home equity loan has a fixed interest rate, similar to a fixed-rate mortgage. This means your interest rate stays the same throughout the loan. Your monthly payments will also remain constant, divided into equal parts for both interest and principal.
· Loan Term and Repayment
Home equity loans usually last from five to 30 years. The payments are stable and easy to plan for in your budget regardless of the term.
What is a Home Equity Line of Credit (HELOC) and How Does it Work?
A Home Equity Line of Credit (HELOC) is a credit type that lets you borrow money up to a defined limit. You can borrow, repay, and borrow again as long as you stay within the limit. HELOCs are secured by the equity in your home.
A HELOC stays open until its term ends. You can use it whenever needed, but you must make minimum payments. The amount you pay will change based on how much you owe.
· Interest Rates
HELOCs usually have variable interest rates, which means the rate can change over time. Some lenders offer fixed-rate HELOCs. Your rate depends on your credit score and the amount you want to borrow.
· Two Phases of a HELOC
Draw Period: You can borrow up to your credit limit. You may only pay interest during this phase, which lasts about 10 years.
Repayment Period: After the draw period ends, you must pay back both principal and interest. This period may last 20 years or more.
Pros and Cons of HEL (Home Equity Loans)
Let’s have a look at the benefits and drawbacks of a home equity loan.
| Benefits of Home Equity Loans | Drawbacks of Home Equity Loans |
| · HELs offer lower interest rates because your home is used as collateral. This can save you money compared to other types of loans. · Home equity loans usually provide a larger amount of money than personal loans or credit cards, which is helpful for big, one-time purchases. · These loans allow you to deduct the interest on your taxes if you use the loan for home improvements. · Home equity loans are also flexible. You can use the money for anything you need, like buying a car or going on vacation. This is different from some loans that are only for specific uses. | · As your home is the collateral, failing to repay the loan means you may end up losing your house. · Unwanted life events such as medical emergencies or job loss can make it harder to repay the loan. · The value of your home could decrease over time, especially with changes in the real estate market. If this happens, you may owe more than your home is worth. · You may have to pay the closing costs of 2% to 5%, which makes these loans more expensive. |
Pros and Cons of HELOC (Home Equity Line of Credit)
Here are the perks and drawbacks of HELOC.
| Benefits of HELOC | Drawbacks of HELOC |
| · A HELOC generally has lower interest rates compared to credit cards and personal loans. This makes it a more affordable option for consolidating debt or funding home renovations. · HELOC allows you to only borrow what you need, and repayments are based on the amount borrowed. This is different from home equity loans, which provide a lump sum that must be repaid in full. · Many lenders offer flexible ways to access HELOC funds, such as debit cards, checks, and online transfers. Some also allow you to convert your balance to a fixed rate. · You may also be able to deduct interest if you use the loan for home improvements. Additionally, a HELOC can improve your credit score if you make timely payments. | · HELOCs offer variable interest rates. That means your payments can increase or decrease depending on economic conditions. Even if you start with a low rate, it can rise later and make payments harder to manage. · A HELOC is a secured loan. That means your home is used as collateral. If you can’t make payments, you risk losing your home. · If property values drop, you may owe more than your home is worth as you are borrowing against your home’s equity. · HELOCs often allow interest-only payments, which can make it easy to borrow money. However, when the repayment period begins, your payments could increase unexpectedly if you have not paid down the balance. |
HEL or HELOC? Which One to Use?
A HEL is ideal if you need a large, lump-sum amount for a specific purpose like home renovation or paying off debt. It offers a fixed interest rate and monthly payments, which makes budgeting easier. However, it involves the risk of losing your home if you cannot repay, and it may come with closing costs.
A HELOC is better for ongoing expenses, such as consolidating your debt, as you can borrow, repay, and borrow again. It offers flexible repayment options, and some lenders provide interest-only payments during the draw period. However, it has a variable interest rate, which means payments can increase over time.
Both are secured by your home’s equity and give tax benefits if you use them for home improvements. A HEL provides a lump sum with fixed payments, while a HELOC offers flexible borrowing with variable interest rates.