If you’ve been a homeowner for a while, you may have a sizeable amount of equity built up. This is the difference between what you owe on your mortgage and what your house is worth. It’s basically how much of your home you own. Typically, this equity grows with every mortgage payment you make.
There is a plethora of reasons to tap into your home equity, from big purchases to paying off debt to even starting your own small business. Many homeowners who want to access this asset choose to get either a home equity line of credit (HELOC) or home equity loan. But what’s the difference? Discover how each loan type could benefit you below.
How They Work
Both HELOCs and home equity loans allow you to borrow against the equity in your property but work in different ways.
A HELOC is a revolving line of credit, much like a credit card. You’re given a draw period, during which you can access your funds at any time. After this period is the repayment period during which you must pay back the loan and are unable to withdraw any more money from it.
A home equity loan is a second mortgage in addition to your original one. This type of loan allows you to receive one lump sum of money, and the amount is dependent on how much equity you have in your home.
What Can You Use These Loans For?
Borrowers usually opt for either a HELOC or home equity loan when they have big expenses to pay for, either all at once or over time, including:
- Home renovations
- Debt consolidation
- College tuition
- Marriage expenses
- Car purchase
- Starting a business
- Funding an investment
- And more
No matter your reason, it’s important to be cognizant of both the benefits and drawbacks of a HELOC or home equity loan to determine which may work for you.
Benefits
Home Equity Loan
Interest Rate: Home equity loans typically have a lower interest rate than other types of loans, meaning you’d pay less in interest over the life of the loan.
Predictable Payments: Since interest rates are usually fixed for home equity loans, your monthly payments may be more predictable. This would help you better budget for other monthly expenses.
HELOC
Interest Rate: HELOCs usually have adjustable interest rates, meaning that they may drop depending on market conditions. This would help lower your monthly payment.
Repayment: You would only pay interest on the amount of money you borrow with a HELOC. Since you would take out funds on an as-needed basis with a HELOC, there’s a chance you wouldn’t use the full amount and therefore won’t need to pay interest on what you don’t use.
Drawbacks
One of the biggest drawbacks to both a HELOC and a home equity loan is that your house acts as collateral. If you’re unable to repay your loan, you may lose one of the most important factors of life: the place you live in. So, if you’re thinking of getting either a HELOC or home equity loan, make sure you’re able to repay it.
Home Equity Loan
Locked Interest Rate: While you may have more predictable payments with a fixed rate, you would have to refinance to secure a better rate if the market changes*.
One Lump Sum: Since you would receive all your funds at once, you can’t take out more money if you find you need it unless you take out another loan.
HELOC
Fluctuating Interest Rate: Since HELOCs typically have adjustable rates, it may be harder to budget since your monthly payments may differ.
Spending: While only paying interest on what you spend can be a huge positive for some, there may be a risk of over- or impulse spending up to your limit.
When Would You Get a HELOC vs. a Home Equity Loan?
Home Equity Loan
If you know you have one specific large expense with a specific cost or if you want stable monthly payments, you may benefit from a home equity loan. Many borrowers choose a home equity loan to make home renovations that put value back into their home or consolidate debt because of the typically lower interest rate.
HELOC
Conversely, if you know you’re going to have multiple expenses over an extended period of time and aren’t sure how much you may spend during this time, a HELOC might work for you. Perhaps there are multiple home improvement projects you need to make or you’re paying college tuition.
Deciding Between the Two
Whether you choose to go with a HELOC or home equity loan really depends on your own circumstances and needs. Either may work. Both may not. But no matter what route you choose to take, it’s good to remember that it doesn’t hurt to speak with a professional about your options, even if you don’t think a HELOC or home equity loan will be appropriate for what you need.
*By refinancing an existing loan, your total finance charges may be higher over the life of the loan due to the extended term.
This information is intended for educational purposes only. Products and interest rates subject to change without notice. Loan products are subject to credit approval and include terms and conditions, fees and other costs. Terms and conditions may apply. Property insurance is required on all loans secured by property. VA loan products are subject to VA eligibility requirements. Adjustable Rate Mortgage (ARM) interest rates and monthly payment are subject to adjustment. Upon submission of a full application, a mortgage banker will review and provide you with the terms, conditions, disclosures, and additional details on the interest rates that apply to your individual situation.
