PUBLISHED: Jul 4, 2024
Homeownership gives you the opportunity to build equity over time. Once you’ve built a substantial amount of equity in your home, you can borrow against it to finance a home improvement project or pay down higher-interest debt. Many borrowers do this by taking out a home equity line of credit (HELOC) or a home equity loan.
HELOCs and home equity loans both allow you to tap into your home’s equity, though they do it in slightly different ways. Let’s look at some of the main differences between a HELOC versus a home equity loan and how to determine which is right for your situation.
Understanding how HELOCs and home equity loans work will help you determine which is right for you. Here’s an overview of a HELOC versus a home equity loan.
A home equity line of credit (HELOC) is an open line of credit that you can draw from on an as-needed basis. A HELOC includes a draw period and a repayment period. During the draw period – which typically lasts between 5 – 10 years – you can borrow up to your credit limit. As you pay down the principal, you can borrow up to the full credit limit again.
Most lenders only require interest payments during the draw period. Once the repayment period begins, you must pay off the outstanding balance, which includes interest and principal payments. Depending on your lender, the repayment period can last up to 20 years.
A home equity loan is often referred to as a second mortgage since it’s a loan you take out using the equity in your home as collateral. Unlike a HELOC, you’ll receive the funds as a lump sum payment and will begin repaying the loan immediately.
Home equity loans usually come with fixed interest rates, so your monthly payments won’t change. The repayment terms can vary but typically are either 10 or 20 years, depending on your lender. Longer repayment terms will make your monthly payments more affordable, but you will pay more in interest over the life of the loan.
Here are the biggest similarities between a home equity loan versus a HELOC:
Here are some of the key differences between a line of credit vs. a home equity loan:
HELOC |
Home Equity Loan |
|
---|---|---|
Distribution of funds |
Distributed as an ongoing line of credit. | Distributed as a one-time lump sum payment. |
Fixed vs. adjustable interest rate and monthly payment |
Usually comes with variable interest rates. | Usually comes with fixed interest rates. |
How interest is charged |
Interest is charged on the amount you actually borrow, not the full line of credit. | Interest is charged on the full loan amount. |
When repayment begins | Interest payments begin during the draw period, interest and principal payments begin during the repayment period. | Repayments begin once the funds have been distributed. |
Added fees | May include an annual fee and prepayment penalty. | May include an origination fee. |
If you want to finance a home improvement project, a HELOC or home equity loan can help you do it. Let’s look at some of the pros and cons of HELOCs and home equity loans.
The main difference is that a HELOC usually comes with variable interest rates and a home equity loan has fixed rates. That means your monthly payments will be more consistent and predictable with a home equity loan. With a HELOC, your payments could go up or down depending on market conditions. Plus, a HELOC allows you to borrow money when you want, versus a one-time loan, but usually comes with additional fees.
A HELOC is best for borrowers who need access to funds over an extended period of time. For example, if you’re financing a home improvement project and don’t know the full extent of the costs, a HELOC may be a good choice.
A home equity loan is a good choice for borrowers who know exactly how much they need to borrow. For example, home equity loans are a good option for consolidating debt since you’ll save on interest charges. A home equity loan is also a good option if you need to finance a home renovation and know how much it’s going to cost.
A cash-out refinance is a popular alternative to taking out a HELOC or home equity loan. This involves refinancing your home for more than it’s currently worth and receiving the difference in cash. However, this option is best if you can refinance your loan and receive better terms and rates than you currently have.
To qualify for either, you must have at least 15% to 20% equity in your home. You’ll also need a good credit score and low debt-to-income (DTI) ratio. You can contact your lender to see if you’re a good candidate for a home equity loan or HELOC.
A HELOC typically comes with faster funding timelines than a home equity loan. However, the exact timeline will depend on your lender, the amount borrowed, your credit score and how much equity you’ve built in your home.
Home equity loans and HELOCs both let you borrow against the equity in your home, but they aren’t the same thing. When you take out a home equity loan, you’ll receive a one-time, lump-sum payment, whereas a HELOC gives you access to an ongoing line of credit. If you’re ready to apply for a home equity loan, you can get started with Rocket Mortgage® today.
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