Finance

Between Home Equity Loan vs HELOC: Which is Best for Covering Expenses?

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If I may ask; between Home Equity Loan vs HELOC: Which is Best for Covering Expenses in the world today? The choice between a home equity line of credit and a home equity loan is sometimes tricky. Here are ways to ascertain which is more preferable; HELOC are better for covering ongoing costs, while home equity loans are best for one-time expenses.

A home equity line of credit, aka HELOC, and a home equity loan are very reliable ways to finance large expenditure by borrowing against the equity in your house. Furthermore, equity is the difference between what you owe [mortgage] and the total worth of your home.

In any case “if you want access to unavailable cash and your primary driver is the equity in your home, it is a simple way to convert equity to cash,” says Bill Dallas, president of Finance of America Mortgage.

HELOCs help you cover ongoing costs, and home equity loans are best suited to one time expenditures. A HELOC and a home equity loan are also candid examples of a second mortgage [a loan that uses your house as its collateral].

Knowledge of this can make a big difference in what you pay to borrow. A lender could charge as much as triple the interest rate for an unsecured loan compared to a HELOC or home equity loan, says Marc Dukes, senior vice president and credit and analytics director, home lending at Huntington Bank.

Similarly, here is more on the differences between home equity loans and HELOCs to help you choose the best option for your financial situation.

How Does a Home Equity Loan Work?

When applying for a home equity loan, the loan will cover a portion of your equity and not the entirety of the amount you owe.

If approved, the total amount is credited in one instalment and paid back in monthly instalments over a 5 to 20 year duration, it sometimes may be up to 30 years, depending on your lender.

Interest rates and monthly payment are fixed for home equity loans, which provides borrowers predictability and keeps you in check from adding to your loan.

“From a standpoint of proper budgeting, it eliminates the temptation of borrowing more or to not pay back as quickly as you intended,” Dukes says.

Advantages of Home Equity Loans:

  • Receive a lump sum payment at a fixed interest rate.
  • Pay a fixed monthly payment over a set period.
  • Choose from long repayment terms of up to 30 years for affordable monthly instalments, or select a shorter term to pay off debt quickly.
  • Borrow at lower rates than personal loans or credit cards because a home equity loan is secured by your property.
  • Deduct interest on qualified home equity loans used for home renovations. (Consult a tax advisor.)

Disadvantages of Home Equity Loans:

  • You will have to pay a second mortgage on top of the primary mortgage.
  • Your home is used as collateral, which means you could lose it to foreclosure if you stop making payments on your home equity loan.
  • You could pay a higher interest rate for a home equity loan than a HELOC because the rate is fixed for the life of the loan.
  • You could tap too much equity at once, which can work against you if property values in your area decline.
  • You could pay closing costs and other fees.

How Does a HELOC Work?

A home equity line of credit is similar to a credit card. You can continuously borrow against the line of credit, making use of as much or as little as needed for a given period of time, and pay interests only on what you borrow.

As with a home equity loan, a HELOC categorically allows you to borrow up to 85% of your home equity. A HELOC, nevertheless, has an interest rate that can vary, which means that the rate can change based on market conditions and other economic situations. Lenders do specify a period of time in which a HELOC’s fixed rate can be for.

There are two basic phases HELOC’s use: borrowing and paying back the line of credit. This first phase is known as the draw period, it is when the HELOC is open to use as and you make minimum payments on what you borrowed.

If you want an extension on your draw period, you may be able to refinance your HELOC. If not, you will enter the second phase known as the repayment phase in which you no longer have access to the line of credit and must pay back your home equity line of credit [HELOC] principal and interest balance simultaneously.

Typically this spans between 15 to 25 years,” Dukes says. “You solely are in a phase of paying back the financial institution.”

Advantages of HELOCs:

  • Tap into funds repeatedly without reapplying for a loan.
  • Borrow exactly what you need, when you need it and only pay back that amount, plus interest.
  • Deduct interest on qualified HELOCs used for home renovations. (Consult a tax advisor.)
  • Offer flexibility with payoff, including the option to convert a portion of your balance to a fixed rate.

Disadvantages of HELOCs:

  • Loan payments and interest charges can fluctuate.
  • Access to a credit line can tempt some people to overspend.
  • If you can’t make payments, you could end up losing your home because it is collateral for the line of credit.

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How to Choose Between a Home Equity Loan and a HELOC

The decision to choose either lies on what you consider more important to you: the predictability of a home equity loan or the flexibility of a HELOC.

When to choose a home equity loan:

  • You know the precise amount you need to borrow.
  • You want to know exactly what your monthly payments will be and when you will pay off the loan.
  • If you prefer a lump sum upfront.
  • You have at least a good credit score to qualify for a home equity loan, although you may need a very good score for the best rates.

When to choose a HELOC:

  • You want to borrow as little or as much as you need up to your credit limit and then borrow again until the draw period ends.
  • You don’t know a precise loan amount but will have long-term expenses such as tuition payments.
  • Your priority is a low interest rate. Interest rates tend to be lower for HELOCs vs. home equity loans.
  • You have a strong credit profile. Lenders prefer applicants with credit scores in the 700s, according to Rocket Mortgage.
  • You know when and how much your variable interest rate might change and you can afford the potential increases.

Can You Get a Home Equity Loan During the Pandemic?

HELOCs and home equity loans are harder to come by during pandemics, even as prices of homes soar and interest rates remain low. Some lenders have put in place more stringent qualifications, while others have completely paused loan facilities and applications.

Wells Fargo and Chase are suspending HELOC applications, and Citi has halted applications for home equity loans and lines of credit. Other lenders may offer these products, but you will need to do your due diligence before you take the time to apply.

If you have shopped around but cannot find a home equity loan that meets your needs, luckily you have not reached a dead end. Here are some alternatives;

Home Equity Loan Alternatives:

  • Cash-out refinancing.
  • Unsecured personal loan, such as a home improvement loan.

A reverse mortgage if you’re at least 62.

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