Understanding HELOCs vs. Home Equity Investments
Many homeowners stumble across home equity investments as they’re doing their research about the best home equity lines of credit (HELOCs). That’s because home equity investments are still fairly new to the home financing world, whereas HELOCs have been an option that gained popularity with homeowners in the early 2000s.
But your decision about how to tap your home equity can have consequences for years—if not decades—to come.
As financial technology evolves, more solutions are made available to fit the unique financial needs of every kind of homeowner. But determining whether a HELOC or a home equity investment is better shouldn’t be overwhelming. Understanding the benefits of each and why homeowners tend to choose one over the other will help you make an informed decision about the best option for you and your property.
What is a HELOC?
A home equity line of credit, or HELOC, functions much like a credit card. During the “draw” period (usually 10 years), you can access the equity you’ve built up in your home as needed. During this period, you’ll usually make payments on interest only. Interest averages about 6.04% but this changes often.
Once the draw period ends, you enter the repayment period (typically 20 years). You’ll pay back the money you borrowed, plus any remaining interest.
What is a Home Equity Investment?
A home equity investment allows you to access a portion of your equity in exchange for an investment of the future value of your home. You receive a lump sum of cash, but
since it’s an investment, there are no monthly payments and no interest. Instead, you settle your investment either when you sell your home or with savings or a loan. The amount you owe depends on your home’s current value at the time of settlement. The term for settling is typically between 10-30 years.
The Difference Between a HELOC and Home Equity Investment
The biggest difference between a HELOC and an equity investment is a HELOC is a loan and a home equity investment is not. Because the settlement amount is based on the home value, an investor isn’t guaranteed to make a profit like a lender is.
But there are some other key differences that may influence which option is best for you.
When a HELOC is a Good Fit
The advantages of a HELOC include having the flexibility to use your line of credit when you need it and not having to pay interest on the money you don’t use (however, check minimum draw requirements first, as you may have to take money even if you don’t have a need).
This may work best for a homeowner who doesn’t have an emergency fund. A HELOC can offer a safety net. You usually have a 10 year “draw” period, meaning if you have a medical emergency five years from when you opened the credit line, you can access funds without having to go through the loan process again.
You may decide a HELOC is the better option based on the amount of funds you anticipate needing. Lenders can allow 75-85% of your available equity to be borrowed, whereas a home equity investment is typically up to 30% or $300,000.
If you have no plans to ever sell your home at any point, you may find a HELOC makes more sense. While it’s not necessary to sell when using a home equity investment, many homeowners use the sale of the home to settle the investment at the end of the term. Otherwise they can choose to refinance, take out a loan, or use savings to settle the investment.
When a Home Equity Investment is a Good Fit
Many debt-adverse homeowners, particularly those looking to reduce existing debt, opt not to use a HELOC because the monthly payments and unpredictable interest rates threaten to dig them deeper into debt. A 2019 study of U.S. homeowners found that 73% of people want financing solutions that don’t create more debt. A home equity investment is debt-free, and there are no penalties for early repayment.
If your expenses are a little unpredictable, an equity investment might also be preferable to a line of credit. Home renovations, for example, can often go over the original budget, and a lump sum of cash makes it easy for homeowners to make adjustments as a project progresses, versus drawing more funds as needed.
Homeowners that don’t fit into the typical box often find that a home equity investment is the better option, as well. For example, entrepreneurs that don’t have a typical W2 or high credit score may not qualify for a HELOC despite having the equity and the financial standing to pay it back.
There’s no one-size-fits-all when it comes to tapping into your home equity. Comparing a home equity line of credit and a home equity investment with your specific goals and financial situation in mind is the best way to determine which one makes most sense for you.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.