A Home Equity Line of Credit, or a HELOC, is a form of financial service designed to let homeowners unlock credit using the equity of their houses as a guarantee. It acts almost as a kind of second mortgage, with the first mortgage taking a primary position as the chief lien-holder on the property. Ever been puzzled about whether to choose a HELOC or a home equity loan?
A home equity loan is similar in that it also allows homeowners to secure a certain amount of money using their home equity as a guarantee, but it differs from a HELOC in some ways. Both allow your home to serve as a collateral while you borrow money, but they each have their unique advantages and disadvantages.
Let’s delve into the contrasts between a home equity loan and a HELOC, discussing their pros, cons, and other details to help you make an informed decision.
HOME EQUITY LINE OF CREDIT (HELOC)
PROS:
A HELOC operates like a credit card, offering a revolving line of credit. You can borrow money, pay it back, and then borrow again, which is convenient for ongoing expenses or projects.
HELOCs often come with lower initial costs compared to home equity loans, making them cheaper to initiate.
Changing interest rates can sometimes be beneficial if rates decrease, as this can lower your borrowing costs.
HELOCs allow you to draw funds as and when required over a certain period, up until reaching your set credit limit.
In certain cases, the interest on a HELOC may be tax-deductible, depending on your fund usage and current tax regulations.
CONS:
Changing interest rates can alternatively lead to higher costs if the rates increase.
The revolving feature of HELOCs can, unfortunately, encourage borrowers to take on more debt than they can comfortably manage.
Failure to repay can lead to you losing your home.
HOME EQUITY LOAN
PROS:
Home equity loans come with fixed interest rates, ensuring your monthly payments always remain predictable.
You receive a one-time lump sum, useful for specific expenses or debt consolidation.
Repayments are structured, making budget management simpler.
CONS:
Rising interest rates can lead to increasing repayment amounts.
Again, it’s important to note that failing to make repayments can result in loss of your property.
GETTING A HELOC AND A HOME EQUITY LOAN
Here’s a summary of the process of securing both types of loans, covering everything from application requirements to closing costs and property appraisal.
1. ASSESS YOUR FINANCES
Determine the current market value of your home and calculate your equity. Equity is the value difference between your home and what you owe on your mortgage.
Based on your financial needs and objectives, decide how much you want to borrow.
2. EXPLORE LENDERS
Compare institutions that offer these loans- banks, credit unions, and online lenders- and look for those offering competitive interest rates and terms.
Consider asking for lender recommendations from friends, relatives, or finance experts.
3. APPLICATION STAGE
Know your equity, and understand that it denotes the portion of your home that you truly own.
Your three-digit credit score is indicative of past debt management. It can fall anywhere between 300 and 850.
In assessing your application, lenders will consider your debt-to-income ratio (DTI), which is your fixed monthly debt divided by your gross monthly income.
4. UNDERGO A PROPERTY APPRAISAL
Your lender may require an appraisal to confirm the current market value of your home.
5. CREDIT REQUIREMENTS
Ensure your credit report is accurate to avoid disputes and to know your creditworthiness. An impressive credit score will help you secure better borrowing terms. Ideally, your credit score should be at least 620 for a home equity loan.
6. CLOSING COSTS
These costs, which include your application fee, title search, and legal fees, vary depending on your location and the specific type of loan. Consult your lender for more information.
7. RECEIVE LOAN TERMS AND CLOSE
If your application is approved, your lender will furnish you with the loan terms, including the interest rate, loan amount, and repayment plan.
You should scrutinize the draft loan including the associated fees and if you agree with the terms, you can finalize the loan agreement by signing it.
Your lender will then finalize the closing procedure, which may include legal document signatures and payment of closing costs and fees.
IN CONCLUSION
Choosing between a HELOC and a home equity loan will depend on your financial aspirations and personal preferences. A home equity loan offers you a lump sum upfront that you repay in fixed payments at a stable interest rate. A HELOC, on the other hand, offers you the opportunity to utilize equity as needed up to a defined limit.
While using your home as collateral affords you these financial benefits, it’s worth remembering that it does involve risks. Missing payments could lead to foreclosure and loss of your home.
