HELOC vs. Home Equity Loan: What’s the Difference?

If you currently own a residence, you might be interested in carrying out a home improvement project, or you might require cash for another form of financial planning. You might be cautious to engage in a cash-out refinance, which refers to the process of refinancing in which you exchange your current mortgage for a fresh mortgage and obtain cash in return.

The primary distinction between HELOC vs Home Equity Loan is that with a home equity loan, the debtor receives an initial lump sum, which is then repaid through a series of predetermined installments. 

With a HELOC, on the other hand, the debtor is allowed to access equity on an as-needed basis, up to a certain maximum. Unlike conventional home equity loans, HELOCs often have a variable interest rate that can go up or down over time.

Let’s compare HELOC vs Home Equity Loan and talk about the benefits and drawbacks of each option, as well as some other considerations so that you can make an informed decision about which one is best for your situation.

HELOC Loan Definition

The equity in your home can be used as collateral for a loan called a home equity line of credit.

When a creditor gives their blessing to a home equity line of credit (HELOC), the homeowner is given the opportunity to draw up to a particular sum against the worth of their residence. Debtors have the ability to take out the funds as they require them and pay them back when they are able to do so.

The initial “draw” period and the “repayment” period are the two distinct components that make up a line of credit. These lines have the potential to continue for a maximum of twenty years, the first ten of which will be used for the draw period.

After a debtor has used some of the available funds from their line of credit, they are responsible for making monthly installments that are equivalent to the total sum of interest that is due for that particular month. 

However, they only give interest on the funds that have been used to draw against their credit limit. The beginning point for rates is normally 2%, in addition to an underlying index such as the prime rate.

How Does a HELOC Loan Work?

A home equity line of credit, or HELOC, is a type of revolving credit that can be used repeatedly, much like a credit card. A line of credit permits you to draw funds whenever you need it, no matter how much or how little, and only pay interest on the funds you actually draw.

You can normally draw up to 85% of your home’s equity with a HELOC, the same as with a home equity loan. However, the interest rate on a HELOC is subject to alter on a quarterly basis in response to fluctuations in the market.

A HELOC’s fixed interest rate may be offered by some creditors for a limited time only.

Borrowing from and repaying a HELOC are two separate processes. In the first part of the HELOC’s lifecycle, known as the “draw period,” debtors can access their funds as needed while making either interest-only or minimum monthly installments.

It’s possible to refinance your HELOC to increase your draw period. If not, you’ll have to start paying back your HELOC’s main and interest balance, which means no more drawing funds against it.

HELOC Loans: Pros and Cons

Pros

• During the draw term, you will only be responsible for making interest installments.
• You will only be charged interest on the sum of funds that you actually withdraw from your line.
• After you have reduced your outstanding balance, you will be able to draw the same sum of funds again.
• In most cases, you have access to the funds in your account for a period of up to ten years.

Cons

• After a predetermined sum of time has passed, either the line must be renewed or the debt must be returned.
• Because interest rates are tied to the base rate, which is subject to change, it is possible that they will rise over time.
• If you do not make regular main installments toward your lines of credit, it may take a very long time for you to pay them off.

Home Equity Loan Definition

A home equity loan is a form of secured loan that gives you the ability to borrow money against the value of your home’s equity once it has been established. Both the interest rate and the time period during which the loan must be repaid have been decided in advance.

Your interest rate is calculated using a number of factors, including your credit score, payment history, the total amount you are borrowing, and your income.

You might be able to refinance into a loan with a more advantageous interest rate if you take out a home equity loan and subsequently see an improvement in your credit score.

It is up to you to pick how the funds from the home equity loan will be used. Some people use it as a way to pay for significant repairs or renovations, such as adding a new room to their home, gutting and rebuilding their kitchen, or bringing their bathroom up to date. 

To eliminate debt with a high rate of interest on credit cards, another option is to take out a loan against the equity in your home at a rate that is both low and fixed.

How Does a Home Equity Loan Work?

Your home’s equity will be used to secure a loan, but you won’t be able to draw the whole value. The typical equity-to-drawing ratio among creditors is 80% to 85%. A home with $80,000 in equity might qualify for a $68,000 home equity loan.

If you are granted a loan, the funds will be transferred to you all at once, and you will have anywhere from five to thirty years to repay the funds. Both the interest rate and the monthly installment on a home equity loan are set in stone, providing stability to debtors and preventing them from incurring any additional costs.

Home Equity Loan: Pros and Cons

Pros

• The interest rate will not change over the course of the loan’s duration.
• Each and every month, the same sum is due.
• When you have a loan with structured installments, the debt will be repaid according to a predetermined timetable.
• When compared to lines of credit, the repayment duration could be significantly longer—up to 30 years.
• There is no requirement that loans be renewed or prolonged.

Cons

• When it comes to the disbursement of loans and the repayment of those loans, there is less freedom.
• As soon as the loan’s closing has occurred, you will be required to begin making interest installments on the total loan sum.
• As the balance of your loan decreases, you will no longer be able to refinance it.
• You can only refinance an existing loan by taking out a new loan; loans cannot be renewed or extended.

A home equity loan might be a stellar option if you need a large sum of funds quickly in order to complete a project for which you already have a stellar idea of the total cost. Just be sure you won’t need to draw funds again soon.

HELOC vs. Home Equity Loan: Which Is Better?

It is dependent on the prerequisites of the debtor to pick between a home equity loan and a home equity line of credit. 

A home equity loan is a stellar option to contemplate, for instance, if you are interested in obtaining a loan that is prearranged and will provide you with specific details on the sum of your monthly installment and the date on which you will be required to reimburse the loan. 

On the other hand, house owners have a lot more leeway with a home equity line of credit (HELOC) if they want a financing choice that is more versatile, or if they aren’t sure how much funds they’ll need or how they’ll put it to use in the future.

How to Choose Between a HELOC and a Home Equity Loan

The choice between a home equity loan and a home equity line of credit (HELOC) could come down to how essential the stability of the installment schedule is to you.

When a home equity loan makes sense:

• Your required loan sum is clear in your mind.
• You need to know the exact sum of your monthly installment and when the loan will be paid off.
• A one-time installment in full is what you’d prefer.
• You can get a home equity loan since you have stellar credit, yet you may need excellent credit to get the best rates.

When a HELOC makes sense:

• You wish to draw as little or as much as you require up to the limit of your credit card, and then draw again as often as you need to up until the draw period is up.
• Long-term costs like tuition will need to be paid, but you don’t know how much of a loan you’ll need.
• A cheap interest rate is a top concern for you. A home equity line of credit (HELOC) often has a cheaper interest rate than a home equity loan.
• Your credit history is excellent. Most creditors look for credit ratings in the 700s when making loan decisions.
• You have calculated any potential increases to your variable interest rate and are comfortable with it.

Final Thoughts

It is possible to get a loan predicated on the valuation of your residence with a home equity loan or a home equity line of credit. Nonetheless, they’re not the same thing at all. 

Think about what you’ll be using the funds for, how much you’ll require, as well as whether you’ll want to draw more to determine which choice is ideal for you. Once you’ve made up your mind, check out several rates and services to get the ideal one for your financial situation.