Home Equity Loan vs. HELOC – What’s the difference?

in the meantime mortgage interest rate is high and economic uncertainty looms, but you already have a mortgage and equity.

according to According to Black Knight’s Mortgage Monitor report, the country’s housing equity positions remain strong relative to early-pandemic positions and are $5 trillion (46%) above pre-pandemic levels. The average mortgage holder has increased by more than $92,000 since the start of the pandemic.

Both a home equity loan and a home equity line of credit (HELOC) are loan products backed by the borrower’s home equity.

But which is the best option for borrowers? Read on to find out.

What is a Home Equity Loan?

A home equity loan – also known as a second mortgage, home equity installment loan or equity loan – is a fixed term loan based on the equity of the borrower’s home. Borrowers apply for a certain amount of money as required and receive that amount in lump sum if approved. A home equity loan has a fixed interest rate and a fixed payment schedule for the life of the loan.

Equity in a borrower’s home acts as collateral for a home equity loan, so a borrower must have enough equity in the home to qualify. The loan amount is based on several factors, including a combination of loan-to-value ratios and whether the borrower has a good credit history. Home equity loans are typically 80-90% of the property’s appraised value.

Home equity loans have fixed interest rates and fixed payments. This means that the interest rate does not change over time and the payments are the same for the entire term of the loan. The term of the equity loan is his 5 to 30 years and the borrower can predict the monthly payments over the term of the loan.

pros and cons

On the positive side, home equity loans have a fixed amount, which reduces the likelihood of impulse purchases, and fixed monthly payments make it easier for borrowers to budget their payments. This type of loan is also suitable for those who need a certain amount of cash for a lump sum payment.

The biggest potential downside of home equity loans is that the borrower may lose their home if they are unable to make timely payments. Additionally, tapping all the assets at once can put you at a disadvantage if the property values ​​in the area drop. Home equity loans also need to be refinanced to get lower interest rates, and borrowers can’t borrow more money for emergencies without taking out another loan.

What is HELOC?

A HELOC is a revolving credit line that allows a borrower to withdraw money against a line of credit up to a pre-set limit, make payments on that line of credit, and withdraw money again. Rather than receiving a lump sum of loan proceeds, HELOC allows borrowers to access credit lines as needed. The line of credit remains open until the end of its term. Borrowing amounts are subject to change. This means that the borrower’s minimum payment amount may also change based on the utilization of the credit facility.

HELOCs are also secured by the borrower’s interest in the housing. Being a revolving credit line, it shares features with credit cards, but while credit cards are unsecured, HELOCs are collateralized by their assets. HELOCs have floating interest rates and may increase or decrease over time. This means that if interest rates rise, your minimum payment may increase. In addition, the interest rate depends on the creditworthiness of the borrower and the amount borrowed.

HELOC terms have two parts: withdrawal period and repayment period. The withdrawal period is the period during which the borrower can withdraw the funds. During this period, the borrower has to make payments, but they tend to be interest-only, so they’re usually small. Once the withdrawal period ends and the borrower enters the repayment period, the borrower can no longer borrow money and the principal and interest borrowed are paid.

pros and cons

HELOC has several advantages. Borrowers can choose the amount of credit facility to use, and that credit facility is available for emergencies and other variable expenses. A floating rate means that the borrower’s interest rate and payments could potentially fall if the borrower’s credit improves or market interest rates fall. Borrowers pay compound interest only on the amount withdrawn and not on the total capital available in the HELOC. HELOC also has lower interest rates compared to other options for earning cash, such as credit cards and personal loans.

However, because HELOCs are collateralized by the borrower’s home, they could default and lose their home if they stop paying on time. It also makes it harder to budget for fluctuating payments and makes it easier for borrowers to accidentally use up their credit limit. A floating rate means that interest rates and payments can potentially increase if the borrower’s credit deteriorates or if market interest rates rise. Also, the transition from interest-only payments to full payments of principal and interest can be difficult for borrowers.

Choosing between a home equity loan and a HELOC

The best way to decide between a home equity loan and a HELOC is to ask the borrower what the loan is for.

A home equity loan is for you if you know exactly how much you need to borrow and how you want to spend that money. Many borrowers use home equity loans for large expenses such as college funding, renovations, and debt consolidation.

If the borrower doesn’t know exactly how much they need to borrow or when they need to spend it, HELOC may be a better option. Borrowers have continuous access to cash for a set period of time and can borrow against the line, repay it in part or in full, and re-borrow the money later, as long as it is within the HELOC’s withdrawal period. . Also, if the borrower needs the money sooner, HELOCs are usually processed slightly faster than home equity loans.

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