A Home Equity Line of Credit (HELOC) is a financial instrument that enables homeowners to unlock a line of credit, using their home’s equity as collateral. This financing option is a kind of second mortgage, but don’t confuse it with your primary mortgage that holds the first claim on the property. Surely, you’ve wondered about the difference between a HELOC and a home equity loan?
A home equity loan is also designed for homeowners who want to use their home’s equity as collateral for a fixed amount of money. Although both options allow homeowners to borrow money against their home’s equity, they each have unique characteristics along with advantages and disadvantages.
Let’s delve into this comparison of a home equity loan and a HELOC. We will discuss their pros, cons, and other essential details to help you make an informed decision better suited to your needs.
HOME EQUITY LINE OF CREDIT (HELOC)
ADVANTAGES:
HELOCs operate like a revolving line of credit, somewhat akin to a credit card. You can borrow funds, pay it back, and borrow again, providing versatility for sustained expenses or projects.
HELOCs frequently have lower opening costs than home equity loans, making them less costly to establish.
Variable interest rates can be a bonus if interest rates fall, as this may lower your borrowing expenses.
With a HELOC, you can withdraw funds as and when you need them within a specified credit limit.
The interest on a HELOC may be tax-deductible in several cases, contingent on the utilization of the funds and current tax laws.
DISADVANTAGES:
While variable interest rates can be beneficial under certain circumstances, they can lead to higher borrowing costs if rates increase.
The revolving nature of HELOCs can tempt borrowers to take on more debt than they can manage.
Failure to repay a HELOC can result in losing your home.
HOME EQUITY LOAN
ADVANTAGES:
Fixed interest rates mean constant monthly payments.
You receive a one-time payment, which can be beneficial for specific expenses or debt consolidation.
Home equity loans provide a scheduled repayment plan, facilitating responsible budgeting and repayment preparation.
DISADVANTAGES:
Increasing interest rates can inflate your payment.
Failure to repay a home equity loan can result in losing your home.
PROCEDURE TO ACQUIRE A HELOC AND A HOME EQUITY LOAN:
Let’s take a look at the process of applying for and securing these home equity-based financial products. Below are the steps which consist of evaluating your financial situation, researching lenders, application process, appraisal requirements, credit requirements, closing costs, and reception of loan terms.
UNDERSTAND YOUR FINANCIAL POSITION:
Determine your home’s current market value and calculate your equity. The value of equity is the difference between your home’s worth and your remaining mortgage balance. Assess your financial requirements and objectives to figure out the amount you want to borrow.
FIND A LENDER:
Compare various lenders, including traditional banks, credit unions, and online lenders. Look for competitive interest rates and contract terms. Consider asking your network for recommendations.
COMPLETE THE APPLICATION PROCESS:
Know Your Equity: Home equity is the portion of your home that you currently own.
Credit Score: Your three-digit credit score reflects your past debt handling. It ranges between 300 and 850.
Debt-to-income ratio (DTI): Calculate your DTI. Lenders measure this as your fixed monthly debt divided by your gross monthly income and express it as a percentage.
PROPERTY APPRAISAL:
The lender may require an appraisal to ascertain the current market value of your home.
CHECK CREDIT REQUIREMENTS:
Obtain your credit report to ensure its correctness and understand your creditworthiness. A decent credit score will assist you in qualifying for better conditions. Aim for a credit score of 620 or higher for a home equity loan.
FIGURE OUT CLOSING COSTS:
Closing costs include the application fee, title search fee, attorney fees, and other charges. These costs vary based on your location and the precise type of loan. Consult with your lender for detailed information about potential closing costs.
CLOSE THE DEAL:
If approved, the lender will offer you the loan terms, including interest rate, loan amount, and repayment schedule. Review the terms and conditions, ensure you’re comfortable with them, and sign the loan agreement to accept the offer. The lender will then finalize the closing procedure, which may include signing legal documents and paying any outstanding closing costs or fees.
To wrap up, the choice between a HELOC and a home equity loan largely depends on your financial goals and personal preferences. A home equity loan proffers a fixed sum upfront that you repay in fixed payments at a fixed interest rate. In contrast, a HELOC allows for flexibility, permitting you to tap into your equity as needed up to a certain limit.
Remember, using your home as collateral carries risks. Failing to fulfill your repayment commitments could result in losing your home. Please think carefully before deciding and make sure you have a solid financial plan in place.
