How to Choose Between a Home Equity Loan and a HELOC

Are you looking to finally build that dream kitchen you’ve been wanting for years? Do you need to consolidate some high-interest debt? Would you like to build a backyard ADU (accessory dwelling unit) to generate monthly income?  Whatever your reason for needing funds, it’s important to do your research and come to the best decision when you’re considering your loan options. Two popular options for homeowners are a home equity loan or a line of credit. However, some people find it hard to choose between the two. Both a home equity loan and a line of credit work to secure funds from an asset you already own. Knowing the difference will help you to make an informed decision.

What Is a Home Equity Loan?

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A home equity loan is similar to getting a second mortgage. A lender will offer a loan amount determined by how much money you still owe on your house and what the home is worth in the current real estate market. To best determine your loan’s interest rate, the lender will review factors such as your credit score and your debt-to-income ratio (how much you owe vs. how much you earn). Home equity loans generally have a fixed interest rate, meaning it won’t change throughout the duration of the loan. Your loan’s terms may include an amortization period of up to 30 years to pay it off.

The lender will make sure the total amount of the loan does not exceed 85% of the home’s worth, so you maintain some equity. For example, if your home is worth $500,000, you could borrow up to $425,000. If you have an outstanding mortgage of $300,000,  you could borrow up to $125,000. 

Should You Get a Home Equity Loan?

A home equity loan is best for you if you prefer predictable payments and need to make a one-time purchase or payment and don’t want to alter your existing mortgage. You will need to know exactly how much you need to borrow and take a financial inventory of your credit score, current income sources, and current home equity.

Since home equity loans have fixed interest rates, you know exactly how much you’ll need to repay each month and over the entire term of the loan. In the loan terms, you can see exactly how much principal and interest you’ll pay, so you will know what to expect. For example, if you plan on borrowing $100,000 at a 3% interest rate over a 10-year period, you can calculate that you’ll pay $15,872.89 in total interest. 

An important consideration to note is that a home equity loan often has higher interest rates than a home equity line of credit because you have the security of a fixed rate. Additionally, because this money is a fixed sum, you would have to apply for an additional loan if you need more money in the future.

What Is a Home Equity Line of Credit?

A home equity line of credit is a revolving line of credit, much like a credit card. A lender will approve a specific limit, and you can take out as much as you need when you need it, then pay it back in monthly installments. Similar to a credit card, you only pay interest on the money you borrow. 

Similar to a home equity loan, you can only get a HELOC for up to 85% of your home’s worth. However, a home equity line of credit often has a lower interest rate to start with. The interest rate can change based on fluctuating economic trends. 

A home equity line of credit has two terms. The first is the withdrawal period, which is the amount of time you have to take out or borrow the money. During the draw period, you will generally pay only interest on the money you’ve withdrawn. The second is the repayment period, which is the time that you will need to repay the money borrowed. For example, if your overall term for the home equity line of credit is 30 years, the withdrawal period may be 10 years, and the repayment period the remaining 20. It is possible to reapply for more funds after the withdrawal period is over, but the approval is up to the discretion of the lender. 

Should You Get a HELOC?

A home equity line of credit is good for you if you require access to cash over a longer period of time. For example, if you are renovating your home over two years, a home equity line of credit can be convenient because you can withdraw money as you need it without having to pay interest on the entire lump sum from the start of the term. 

The monthly payments are generally lower at the beginning during the draw period when you are paying back interest only. Keep in mind that, as you withdraw more money, your monthly payments on the loan will change.

During the repayment period of the home equity line of credit, you will need to pay back the interest and the principal amounts. The increase in payments can sometimes come as a shock. If the payments become too large to pay back, the lender may use your home as collateral, or they can revoke the amount of money that is available on the home equity line of credit at any point should they fear repayment is no longer possible. This could mean you would need to sell your home to free up money to pay back the loan. 

After looking at a home equity loan vs. a line of credit, you should evaluate what you intend on using the money for and how long you will need it. This will help you choose the right option for you between a home equity loan and a line of credit. 

If you want to explore an alternative that doesn’t require monthly payments, learn more about Point’s home equity investment. With the HEI, you can tap into your existing equity and receive a lump sum of cash. You pay nothing for up to 30 years. In return, Point receives a portion of your future home appreciation. You maintain complete control over your home.

The qualification criteria are more flexible than with a home equity loan or HELOC, and you still have access to your home equity even if your credit score or debt-to-income ratio would keep you from getting a more traditional financial product. Get the funds you need by working with Point. 

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