Home Equity Loan vs. HELOC: Know the Differences
Before any big fight, boxing fans will size up the contenders on strength, size, and endurance. You should do the same when you step up to the ring to convert your home equity into cash.
Home equity is a valuable asset, which is why lenders will pay cash to get a piece of it. Two standard credit facilities can manage this cash-for-home-equity arrangement-a home equity loan or a home equity line of credit (HELOC). Whichever one you choose, the lender will require a security interest in your home, which is only a problem if you can't repay the money as scheduled. At that point, the lender can foreclose.
In one corner, you have the home equity loan. In the other, you have the HELOC. Which one gives you the biggest financial punch?
The brawny HELOC
HELOCs are structured like credit cards. You have a maximum credit limit, and can borrow against it as needed. This makes the HELOC a nice choice for funding an ongoing expense, such as college tuition. The minimum payment on a HELOC generally covers only the interest and, sometimes, a small bit of principal. The interest rate is variable, and the payment amount fluctuates based on how much money you've borrowed and the current interest rate.
HELOCs don't typically have closing costs. Add that perk to the low monthly payments, and the HELOC gives you access to a lot of cash, with very low out-of-pocket requirements.
The strength of equity loans
If you'd prefer a lump sum of cash upfront, a home equity loan is right for you. Your out-of-pocket expenses will include both closing costs and amortizing monthly payments. Because they're designed to bring your loan balance to zero at the loan's maturity, home equity loan payments are higher than those of a HELOC. Both the interest rate and monthly payment amount on a home equity loan are fixed.
While home equity loans have higher out-of-pocket costs, they're more stable over time because the payments never change. They're most appropriate for large, one-time expenses, like a home remodel.
Size and endurance
Both loans give you access to equivalent amounts of cash - most lenders will let you borrow up to 80 percent of your home equity. Some may even allow you to go beyond that, if you have good credit and a manageable debt-to-income ratio.
Home equity loans mature more slowly than HELOCs. The former might mature in 30 years, while the latter might expire in 10. One big distinction is that HELOC minimum payments aren't designed to pay down the principal. As a result, you could make your payments on time, and still owe money when it expires. In this scenario, you'd have to refinance the remaining debt, either with another HELOC, or an amortizing mortgage.
Sizing up these contenders, you can see there's no knockout punch for either competitor. Both the home equity loan and the HELOC are useful financial tools that can help you win in the home equity ring.
Follow us on Twitter and Facebook.
Recent Articles
Wave of Home Equity Defaults Coming?
Aaron Crowe
How Refinancing Can Hurt Insurance Rates
Kara Johnson
How can I get preapproved for a home loan?
Kirk Haverkamp
Proof of Income for a Mortgage
Kirk Haverkamp
