A Home Equity Line of Credit or HELOC is a financial instrument that offers homeowners an access to a credit line by using their home equity as collateral. Acting as a second mortgage, the original mortgage retains its position as the primary lien on the property. Another option to consider would be a home equity loan, which essentially serves the same purpose by allowing homeowners to borrow a fixed amount of money against their home’s equity. However, there are subtle differences, each with its own set of benefits and drawbacks.
Let’s delve into a detailed comparison between a home equity loan and a HELOC, to help you determine the most suited option for your circumstances.
HOME EQUITY LINE OF CREDIT (HELOC)
Advantages:
HELOCs operate similar to a revolving credit line, akin to a credit card – it offers the liberty to borrow, repay, and re-borrow, accommodating ongoing expenses/projects.
The initial expenses associated with setting up a HELOC are often lower than home equity loans, making them more cost-effective.
Interest rates of HELOCs are variable, which could reduce borrowing costs if rates drop.
It offers the flexibility of withdrawing funds as necessary within a defined credit limit.
In several cases, the interest on a HELOC could be tax-deductible, subject to the usage of the funds and prevailing tax laws.
Disadvantages:
Variable interest rates, while beneficial at times, could lead to increased interest costs if rates escalate.
The flexibility of HELOCs may entice borrowers to incur more debt than manageable.
Failure to repay can result in losing your home.
HOME EQUITY LOAN
Advantages:
Interest rates are fixed, ensuring consistent monthly payments.
The loan amount is provided as a lump sum, ideal for significant expenses or consolidating debt.
Home equity loans come with a predefined repayment schedule, facilitating better financial planning.
Disadvantages:
Rising interest rates could increase your payment amount.
Non-repayment can lead to foreclosure.
STEPS TO ACQUIRE A HELOC AND A HOME EQUITY LOAN
Following is a comprehensive breakdown of the process, from applying, understanding credit requirements, to estimating closing costs and appraisal requirements.
1. ASSESS YOUR FINANCES: Calculate the market value of your home and the outstanding mortgage balance to determine your equity. Propose an amount that you intend to borrow pursuant to your financial needs and goals.
2. RESEARCH LENDERS: Evaluate the offerings from banks, credit unions, and online lenders. Consider recommendations from your social circle or financial advisors.
3. APPLICATION: Understand your home equity, credit score, and Debt-to-income ratio (DTI) for a successful application.
4. APPRAISAL: Expect a property appraisal to verify the market value of your home.
5. CREDIT REQUIREMENTS: Review your credit report for accuracy. A desirable credit score would be 620 or higher for a home equity loan.
6. CLOSING COSTS: Be prepared for application fees, attorney fees, title search, and other associated costs.
7. LOAN CLOSURE: Upon approval, you will be provided with the loan’s terms. If agreeable, proceed to sign necessary legal documents and pay closing costs.
Ultimately, the decision between a HELOC and a home equity loan boils down to your personal preferences and financial aspirations. Remember, using your home as collateral comes with certain risks, including potential foreclosure for non-repayment.
