A Home Equity Line of Credit, or HELOC, is a financial instrument that enables homeowners to unlock a line of credit using the equity they’ve accumulated in their homes, serving as collateral. It’s a form of a second mortgage, with your primary mortgage being the first claimant on the property.
On the other hand, a Home Equity Loan allows homeowners to borrow a lump sum, using the equity in their homes as security, like a HELOC. Both options leverage your home equity to secure loans, however, they have unique features, advantages, and disadvantages.
In comparing the two, let’s delve into the details of a home equity loan vis-à-vis a HELOC along with their benefits and drawbacks to guide you in deciding what’s more beneficial for your situation.
HOME EQUITY LINE OF CREDIT (HELOC)
PROS:
HELOCs are akin to a revolving line of credit, much like a credit card. You can borrow funds, repay, and borrow again, providing adaptability for continuous expenses or projects.
Often, HELOCs have lower immediate costs compared to home equity loans, making them more affordable initially.
A variable interest rate could be a boon, especially when interest rates drop, which in turn may decrease your cost of borrowing.
With a HELOC, you’re endowed with the capacity to withdraw funds as necessary over an extended duration, up to a pre-set credit limit.
In several instances, the interest on a HELOC may be tax-deductible, thanks to current tax laws, and depending on how the proceeds are used.
CONS:
While variable interest rates can sometimes be advantageous, they can also lead to increased interest costs if the rates escalate.
The cyclic nature of HELOCs can be risky, as borrowers may be enticed to mount more debt than they can manage.
Failure to repay could lead to the forfeiture of your home.
HOME EQUITY LOAN
PROS:
The interest rates are fixed, making your monthly repayments predictable.
A one-time lump sum payout is provided, ideal for addressing specific expenses or consolidating debt.
Home equity loans follow a pre-determined repayment schedule, facilitating easier budgeting and planning for repayments.
CONS:
With rising interest rates, your repayment could increase.
A default in repayment could cost you your home.
TO SECURE A HELOC AND A HOME EQUITY LOAN
To guide you in procuring a home equity loan or a HELOC, let’s walk through the steps, including application, credit prerequisites, associated costs, and appraisal requirements.
1. Review and analyse your financial standing: Ascertain your property’s present market value and compute your equity, which is the difference between the property’s worth and your outstanding mortgage balance. Determine the amount you intend to borrow based on your financial needs and goals.
2. Compare several lending institutions: Contrast and compare an array of lenders like banks, online lenders, and credit unions, paying attention to competitive interest rates and terms. You might also consider seeking advice or recommendations from trusted relations or a financial advisor.
3. Application process: Understand the following key parameters:
– Home Equity: This refers to the section of your property that you truly own.
– Credit score: This is a numerical expression, within the range of 300-850, that indicates your creditworthiness based on past debt management.
– Debt-to-income ratio (DTI): Lenders will scrutinize your DTI, calculated as your total monthly debt divided by your gross monthly income, converted into a percentage.
4. Appraisal: Lenders might require a property appraisal to determine its current market value.
5. Credit prerequisites: Obtain your credit report to ensure accuracy and to understand your creditworthiness. A higher credit score – ideally, 620 or above – will attract better terms for a home equity loan.
6. Closing costs: These include application fee, title search, and attorney fees. They depend on your locale and the specific loan type, and you should consult with your lender for further details on potential expenses.
7. Receive loan terms and completion: Post approval, you’ll receive your loan terms – including loan amount, interest rate, and repayment schedule – from the lender. Once the terms are reviewed and accepted, the lender proceeds to finalize the loan process. This could include signing legal documents and covering any closing costs or fees.
In conclusion, whether a HELOC or a home equity loan suits you best depends on your financial goals and personal preferences. A home equity loan provides an upfront sum repayable via fixed payments, while a HELOC offers flexible equity access up to a certain limit. Remember, using your home as collateral does pose risks, as failure to repay could lead to property foreclosing.
