A Home Equity Line of Credit (HELOC) is a financial tool that allows homeowners to tap into the equity of their homes to secure a credit line. It functions like a second mortgage, with the first mortgage viewed as the primary lien on one’s property. Likewise, have you had to make a choice between a HELOC and a home equity loan?
A Home Equity Loan, on the other hand, enables homeowners to borrow a fixed amount of money against their home equity. Both financial products require your property as collateral but have distinctive features along with their specific pros and cons.
To make it easier for you, let’s delve into the comparison between a home equity loan and a HELOC, discussing the advantages and disadvantages (and a few more details) to better help you decide which is the best fit for you.
HOME EQUITY LINE OF CREDIT (HELOC)
ADVANTAGES:
Similar to a credit card, a HELOC operates like a revolving line of credit, meaning you can borrow, repay, and reborrow, offering flexibility for ongoing costs or projects.
HELOCs generally offer lower initial costs than home equity loans, making them economically feasible options.
If interest rates fall, the variable interest rates of HELOCs may reduce your borrowing costs.
A HELOC allows you to draw funds as necessary over an extended duration, up to your approved credit limit.
In some situations, the interest on your HELOC might be tax deductible, depending on your usage and prevalent tax regulations.
DRAWBACKS:
Fluctuating interest rates can potentially lead to increased interest expenses if rates surge.
Because of their revolving nature, HELOCs can tempt borrowers to accrue more debt than they can comfortably manage.
Failure to repay a HELOC can potentially lead to foreclosure.
HOME EQUITY LOAN
ADVANTAGES:
They come with fixed interest rates, creating predictable monthly payments.
You receive a lump sum, which can be favorable for specific expenses or debt consolidation.
Home equity loans come with a definite repayment schedule, facilitating better budget and repayment planning.
DRAWBACKS:
Spike in interest rates can raise your payment amount.
Failure to repay can lead to foreclosure.
HOW TO SECURE A HELOC AND A HOME EQUITY LOAN
Here is a step-by-step process to obtain a home equity loan or a HELOC, including the application process, credit requirements, any closing costs, and appraisal requirements.
1. ASSESS YOUR FINANCIAL STANDING
Determine your home’s current market value and your equity. Your equity is the gap between your property’s value and your outstanding mortgage balance.
Assess your financial needs and objectives to figure out how much you aim to borrow.
2. COMPARE LENDERS
Look into different lending sources, including banks, credit unions, and online lenders. Seek the ones offering competitive interest rates and terms.
Consider getting recommendations from your network including friends, family, or financial advisors.
3. BEGIN THE APPLICATION
Analyze your equity: Your home equity is the proportion of your home you genuinely own.
Credit rating: Your credit rating is an indicator explaining how well you’ve handled debt in the past.
Debt-to-income ratio (DTI): Your lender will assess your DTI, which is your fixed monthly debt compared with your gross monthly income, given as a percentage.
4. CONDUCT A PROPERTY APPRAISAL
Your lender may necessitate an appraisal to determine your home’s present market value.
5. ASSESS CREDIT REQUIREMENTS
Acquire your credit report to ensure it’s precise and to comprehend your creditworthiness. A high credit score will improve your chances of gaining better terms.
Aim for a minimum credit score of 620 for a home equity loan.
6. ESTIMATE CLOSING COSTS
Closing costs cover your application fee, title search, attorney fees, and other levies. The costs differ by location and loan type.
7. ACKNOWLEDGE LOAN TERMS AND COMPLETE THE CLOSING
Once approved, your lender will prescribe terms, including interest rates, loan amount, and repayment plan.
Review these terms, and if satisfactory, finalize by signing the agreement.
Your lender will wrap up the closing process, which may involve signing legal documents and paying closing costs.
The decision between a HELOC and a home equity loan depends on your financial goals and personal preferences. A home equity loan offers an upfront lump sum with fixed interest rates, while a HELOC provides access to funds as needed up to a certain limit.
However, always remember that putting your home as collateral comes with risks, like the potential loss of your home if you fail to make payments.
