HELOCs & Home Equity Loans: What’s the Difference and Is Either Right for You?
When you have a financial need and are in a bind for cash, you may consider a second mortgage. While your first mortgage, or purchasing loan, is guaranteed by a lien on your home, a second mortgage lets you borrow money based on your home’s value. A home equity line of credit (HELOC) or a home equity loan are two of the most common types.
A HELOC acts as a credit card, using your home’s equity as a source of funds. According to TransUnion, almost five million consumers opened a HELOC between 2013 and 2017, and that number is expected to double over the next five years. The rise in popularity may be attributed to the few, if any, closing costs and variable interest rates.
A home equity loan, on the other hand, allows you to borrow against the equity you’ve accrued, using the home to guarantee the loan.
But which one, if any, is right for your situation?
Determine if You Qualify
To qualify for either loan, you’ll need a minimum FICO score of 680, maximum loan-to-value rate of 80–85%, and maximum debt-to-income rate of 43%. Both often include prepayment penalties, with HELOCs often including cancellation fees, too.
Identify Your Need
If you have a high expense, like a remodel or college tuition, home equity loans are often a better choice because you receive a larger lump sum. These loans are also better for consolidating debt because you get a single payment, often with a lower interest rate.
As Investopedia explains, HELOCs are better for short-term financial needs since the interest of these loans can vary. They’re also good if you aren’t sure how much you need to borrow and when you’ll need to borrow it since HELOCs give you access to cash for a set period, in some cases up to 10 years.
Compare Interest Rates and Fees
Home equity loans have higher interest rates. Since they’re typically adjustable-rate loans, HELOC monthly payments and interest rates may go up, making payments unreducible. However, with either loan, you’ll likely pay a lower interest rate than you would with an unsecured loan.
Home equity loan fees typically include closing fees plus 2–5% of the value of the loan. HELOCs require $0 at closing but usually have annual fees and minimum draw requirements.
Weigh the Risks
With HELOCs, your lender may lower your credit line or even revoke it if the value of your home decreases or your financial situation worsens. Also, if you default on either type of loan, you risk foreclosure.
Consider Your Alternatives
While a HELOC or home equity loan is a viable financing option, it requires you to use your home as collateral—and defaulting on that loan could result in foreclosure. Hometap can offer you access to the equity accrued in your home in cash today without any interest or monthly payments.
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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.