HELOCs and home equity loans have one main thing in common: they’re secured by your home. You stand a higher chance of getting either if you’ve cleared a significant part of your mortgage.
This post looks at various aspects of both loan options, from their differences to their pros and cons so choosing can be a breeze for you.
Read Also: Bridge Loan vs HELOC and Home Loan Borrow Amount
Differences Between HELOC and Home Equity Loan
The following table highlights the differences between HELOC and home equity loans:
| Home Equity Loan | HELOC | |
|
Interest Rate |
Fixed | Variable |
|
Monthly Payments |
Same each month |
Changes with time |
| Disbursement of Funds | Upfront lump sum |
As required |
| Repayment Terms | Begins as soon as the loan is disbursed |
Interest-only payments during draw duration; repay principal and interest after |
Home equity loan is a fixed-rate loan where the borrowers get a lump-sum upfront which should be repaid in installments over an agreed duration. While HELOC is a line of credit with variable interest rates and it allows homeowners to borrow money when needed.
Home Equity Loan
Also referred to as second mortgages, equity loans, and home equity installment loans, home equity loans are loans that enable you to utilize the equity you’ve built in your space as security to borrow cash. Borrowers apply for a set quantity that they require. They get that money in a lump amount up front if the request is approved.
Pros and Cons
The following are some of a home equity loan’s advantages and disadvantages:
Pros
- Some financial institutions won’t charge origination fees
- You receive a predictable monthly payment and a fixed interest rate
- You access more money since you get the funds instantly in a lump sum
- Terms are longer than many other consumer credits
- The credit paid on loan may be tax deductible if the proceeds are used to upgrade your space
Cons
- It can have higher closing costs
- It’s less flexible than a HELOC
- financial institutions may need higher credit scores than traditional mortgages
- Credit is charged on the complete credit amount despite how much of it you use
- You can’t take out more for an emergency without another loan
Loan Security and Terms
Your home’s equity serves as collateral. It’s also called a second mortgage since you have another credit payment to make on top of your primary mortgage. There has to be sufficient equity in the home – you have to pay down the first mortgage by enough to make you eligible for the equity loan. Several factors determine the loan amount you’ll receive.
One is the combined loan-to-value (CLTV) ratio – the ratio of all combined loans on a property to a property’s value. The loan amount is usually 80-90% of the property’s appraised worth.
Other factors that influence a financial institution’s decision to loan a borrower are if they have a good credit history and credit score (a digit from 300 to 850 that determines a borrower’s creditworthiness). Please note that features and terms of lines of credit and home equity loans may vary between financial institutions.
Payments and Interest Amount
A home equity loan’s credit rate is fixed. Additionally, its payments are fixed, equal quantities over the loan’s life. A bit of each payment goes to the loan’s principal amount and interest.
An equity loan’s term can usually range from five to thirty years. However, the financial institutions must accept the term’s length. Borrowers will still enjoy predictable and stable monthly payments despite the duration.
See Also: HDB Bridging Loan
HELOC
A home equity line of credit (HELOC) is a revolving line of credit protected by your home. It provides you with a revolving credit line to use for massive expenses and might have a revolving balance. Or to consolidate higher interest rates on other loans like credit cards. Its interest rate is usually lower than other credit types, and the interest may be tax deductible.
Pros and Cons
Here are some of its advantages and disadvantages:
Pros
- You can borrow the same funds once more after clearing your balance
- You only clear interest on the cash you draw on your line
- Some financial institutions don’t charge closing costs
- There’s a credit line available for emergencies
- You get to decide how much or less of your credit line you’re going to use
Cons
- You could lose your space if you default or delay payment.
- Credit score matters – borrowers with a perfect credit score (FICO score of 670 and more) receive the best home equity loan rates.
- You must refinance to receive a lower interest rate.
- You need another loan to handle an emergency since the amount is fixed.
- You require plenty of home equity to be eligible for it- at least 15-20% or more.
Loan Security and Terms
The equity in your home secures HELOCs – just as is the case with home equity loans. HELOCs are similar to credit cards since they’re revolving credit lines. The major difference between them is HELOCs are secured while credit cards are unsecured.
HELOCs have inconsistent interest rates. The minimum payments can increase as rates rise because of that. Some financial institutions decide to go against the norm and provide a fixed rate of interest for them. The rate depends on your required amount and your creditworthiness.
Draw and Reimbursement Durations
HELOC terms are split into the draw (withdrawal) duration and the repayment period. You enter the repayment period when the draw period ends.
The withdrawal period lasts roughly ten years. Meanwhile, the repayment phase lasts approximately twenty years, making a HELOC a thirty-year affair. Please note that you can’t borrow any more cash once the withdrawal period ends.
You still have to make (interest-only) payments during the draw period. This leads to the payments made during this duration being small. However, they grow during the reimbursement period. This is because the principal amount borrowed is part of the payment schedule plus the interest.
Pointers on Selecting Between a Home Equity Loan and HELOC
Choosing which is better for you between a home equity loan and HELOC doesn’t have to be complicated. Here are some straightforward pointers to point you in the right direction if you’re in a fix:
You can borrow money through a home equity loan if:
- You’re investing in real estate
- You need some quick cash for home improvement projects
- You’re consolidating debt.
- A fixed monthly payment works well with your monthly budget
- You prefer fixed rates to variable ones
Consider settling for a HELOC if:
- You have upcoming expenses like college tuition.
- You’re looking to start an emergency fund if you’re short on savings.
- You’re taking part in extended ‘pay as you go’ home enhancements.
- You’d like to borrow and withdraw funds as much or as tiny as you’d like when you need them.
- You’re alright with fluctuating payment.
How to Receive a HELOC or Home Equity Loan
Here are some of the qualifications you’ll have to meet if you’re hoping to increase your chances of getting either of the loans:
- Low debt- most financial institutions prefer borrowers with a debt-to-income ratio of 36% or less.
- Solid payment history- do you have a long history of clearing your debts on time? If yes, you’re a step closer to receiving a loan!
- Excellent credit- your eligibility chances are higher if you have a credit result in the mid-600s. You’ll enjoy the best rates if you score above 700, such as no down payment.
- Substantial equity in your space- you’ll need at least an 80% loan-to-value ratio and 20% home equity. That means your mortgage balance and any home equity loans total no more than 80% of your home’s worth.
- Enough income- you must prove that you have enough cash to pay your debt.
Application Procedure
The following is a complete process of applying for home equity loans:
- Financial institutions will check your debt-to-income (DTI) ratio, equity, and credit score.
- They’ll also check your credit score- it has to clock 620 or more so you can qualify for a home equity loan. The figure is slightly different for a HELOC- mid 600s. As per Rocket Mortgage, financial institutions accept a score of above 700.
- You’ll be required to pay closing costs for both loans. Home equity loans have higher prices, though. Closing costs pay for fees such as attorney fees, application fees, title search charges, and other fees, as they depend on your loan type and location.
- A real estate appraiser determines your home’s actual fair market value. Both loans have a similar appraisal procedure since it’s likely that you’ll undergo a complete appraisal. They may use a computer to perform the inspection.
Other Options Other Than Home Equity Loans or HELOCs
Both loans boast impressive perks and features. However, they may not be suitable for some financial situations. Here are some other loan alternatives that might work for you:
- A personal loan: works best if you’d like to borrow a small amount. Its loan term is shorter, and it’ll have a higher interest rate, but hey, it’s unsecured. An example is a home improvement loan.
- A balance transfer credit card: it’s ideal for you if you’re hoping to consolidate credit card debt and have perfect credit. You can save big on cash by doing a balance transfer onto a credit card with a 0% APR.
- A cash-out refinance: it enables you to tap into your home equity by taking out a new mortgage bigger than your current one and keeping the difference as cash. You’ll only have one monthly payment since the money you borrow is rolled into your new mortgage.
Other Things You Need To Know
1. Can You Be Penalized for Paying a Home Equity Loan Early?
Most home equity credits don’t have a prepayment fine. However, some HELOCs have penalties crafted to regain loan closing costs that a financial institution may have waived earlier.
2. Can You Borrow a Home Equity Loan and HELOC Simultaneously?
Yes, you can, but it may not be a good idea. It’ll be more challenging to qualify with each new application since your equity will keep decreasing with each loan.
Assuming your home is worth S$500,000 and several home equity loans are adding up to S$425,000. You’ve borrowed 85% of your home’s worth – the cap for most home equity providers.
3. How Can You Determine Your Home’s Value?
There are several ways you can determine property values:
- Using tools such as SRX X-Value Pricing, EdgeProp’s Edge Fair Value, and Ohmyhome Valuation Calculator. Please note that these tools provide an indicative value. You can obtain the value by factoring in the average cost of similar properties to yours purchased and sold in your locale.
- Employing the services of a licensed and expert valuer or surveyor. The professional will assess your home and appraise its market worth
Final Word
To sum it up, home equity loan pulls you away from impulse spending by giving you a fixed lump sum, and having a fixed monthly payment will be easier for you to budget your repayment. However, when emergency comes, you can no longer get more funds without getting another loan.
While with HELOC, you are in control of how much to use, allowing you to only get what you need at the moment. But because you are in control, chances of impulse-spending is higher and your monthly payment is likely to fluctuate.
Key Takeaways
- Home equity loans and HELOCs are home equity lines of credit that use your home as collateral.
- With a home equity loan, you receive your loan in a lump sum upfront if the loan proceeds are disbursed. With a HELOC, you receive a credit line to a predetermined amount and you can use as much as you prefer up to the credit limit.
- A HELOC is more flexible than a home equity loan.
- HELOC has a variable interest rate, while home equity loans have fixed payments.
- A home equity loan is more suitable if you need funding for a home renovation project. A HELOC might work for you if you prefer an adjustable interest rate, have ongoing funding requirements and prefer having access to your money anytime.
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