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Home Equity Loan vs HELOC, What's the Difference?

Homeowners who are looking for a home loan can choose between a home equity loan or HELOC (home equity line of credit) by exercising the right choiceof which is good for their needs.

 

by Damodharan N

Updated Apr 17, 2024

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Home Equity Loan vs HELOC, What's the Difference?

Home Equity Loan 

Home equity loans offer loans to people for fixed interest rates and terms by using the home as collateral. It is considered a secured loan as an asset that backs the loan. In the event of non-repayment, the home can be confiscated as a foreclosure.

This loan type is called a second mortgage. This loan amount will be given as a lump sum upfront. This type of loan offers 80–90% of the home's appraised value. There are other factors in determining the loan value, like a combined loan-to-value (CLTV) ratio, which will be used by the loan givers based on the previous loan history of that home and the purchase value. And this can be calculated with this formula: 

CLTV Ratio = (Loan 1 Balance + Loan 2 Balance +...) / (Property Value)

One thing that borrowers of this loan can be sure of is the interest rate and monthly repayment schedule, which offer stability and reliability compared to other types of loans that can fluctuate due to market forces.

If you are a keen budgeter, then this loan can technically be used for other purposes, like tuition fees for your college kids education, if you spend the home repair expenses on a much smaller amount.

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Home Equity Loan vs HELOC 

The Home Equity Loan and HELOC (Home Equity Line of Credit) are loans that are based on giving loans using the home as collateral. Now let's look at some of the key differences between these two popular home loans. 

S. No

Home equity loan

HELOC (Home Equity Line of Credit) 

  1.  

Home equity loans can be provided with a fixed-interest rate. 

HELOC loans are offered at a variable interest rate.

  1.  

Monthly payments will remain the same, as the interest rate will remain the same throughout the life of the loan. 

Monthly payments will vary as the interest rate varies.

  1.  

The total loan amount can be received in one lump sum. 

Allows you to take the loan amount up to the credit line up to a preset limit.

  1.  

The repayment period can last 5–30 years. 

The repayment period can last for 20 years.

  1.  

It is easy to complete the budget for the loan as it has a fixed interest rate. 

It is harder to maintain the budget for the loan due to the variable interest rate. 

  1.  

No, there are no interest-only payment options. 

This type offers an interest-only payment option during the draw period of the loan. 

  1.  

This loan can be used to cover other expenses if you budget your expenses for your home. 

The possibility of using this loan for other expenses is less since the amount will be flexible enough to borrow as little as your home needs.

  1.  

There is less spending on this type of loan as it has a fixed term.

The line of credit limit can be exhausted if you are not mindful of your expenditures. 

  1.  

Suitable for budgeters and those who want to have stability in their loans. 

It is suitable for people who are well versed in how credit and home finance work. 

  1.  

In the event of non-repayment of the loan, the home will be taken as collateral. 

In the event of non-repayment of the loan, the home will be taken as collateral.

From this difference, borrowers can get the gist of various structural similarities and dissimilarities built into each loan and choose based on their needs.

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Pros and Cons of a Home Equity Loan 

The home equity loan offers stability and reliability, but it does have many positives and negatives built into it. 

Pros of a Home Equity Loan 

  • This loan has fixed interest and term periods based on the borrower's needs.
  • The interest rate can be low for a home equity loan. 
  • This loan has a low origination fee, which will be a big saver when you are closing the loan.
  • The interest on the loan can be tax-deductible. If the entirety of the loan amount is used for the home upgrade,. 
  • This loan gives lump-sum payments and is used for other purposes if you are prudent in your finances.
  • If borrowers make timely payments, there is a chance of improvement in their credit score.

Cons of a Home Equity Loan

  • The calculation of the loan amount needs to be absolute, as this will determine the loan for which you are eligible for your home upgrades.
  • If the property value decreases, then the borrowers need to pay more than their property value, which can jeopardize your budget plans. 
  • Fixed interest rates cannot pass the benefits of low-interest market rates due to fluctuation.
  • Possibility of losing the home due to timely non-payment of the loan
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HELOC 

HELOC is revolving credit based on the borrower's home equity level; it almost works like a credit card limit. One can borrow up to that credit level during the draw period and repay it during the repayment period.

In the draw period, borrowers will make interest-only payments, and in the repayment period, the principal amount is also included, making the repayment amount much higher. Borrowers of this loan need to be aware of the credit limit, as this loan will make the borrowers rapidly exhaust the credit limit.

This loan is suitable for people who want to reap the benefits of the variable interest rate that is available with this loan. As this is a secured loan using the home as collateral, non-repayment leads to the foreclosure of the home.

And HELOC is specifically used for repairs in the home, as the amount users can need is variable. This loan is used for that kind of exigency purpose. The factors that can affect getting this loan are a credit score should be above 680, a median home equity level, a good debt-to-income ratio, and a stable per capita. 

Pros and Cons of HELOC 

The HELOC loans, as with any other loan, offer the borrowers a wide variety of positives and negatives. Let's look at some of them.

Pros of HELOC

  • HELOC offers interest-only payments for the credit limit borrowed during the draw period. so it can be convenient during the initial period. 
  • Revolving credit can be used extensively in order to get more money during emergency spending on your home. 
  • This offers flexible options like fixed interest rates for some parts of the loan and variable interest rates for the remaining half of the loan to shield from market fluctuations and be budget-friendly.
  • The loan amount desired will be given on a when-and-where basis, not a lump sum upfront. So it will be used exactly for the purpose for which the loan is given, not for discretionary spending. 

Cons of HELOC

  • A decrease in home value can lead to negative equity, which will affect the loan value. 
  • Financially, not being prudent enough can make your credit limit exhaust quickly.
  • The possibility of losing the home in this scenario is much more likely due to variable interest rates and non-timely repayment. 
  • As with any revolving credit, users can be asked to pay a lot of fees depending on the borrowing financial institution, so always choose the correct mix for your needs.

Home Equity Loan vs HELOC  - FAQs

1. What is a home equity loan?    

This secured loan is based on the borrower's home as collateral, with a fixed interest rate and term offering stability and reliability.

2. What factors can affect getting the HELOC?  

The factors that can affect getting HELOC are credit score, debt-to-income ratio, home equity level, and stable income. 

3. What is positive about the home equity loan?  

The positive about the home equity loan is the predictability of the loan amount. 

4. Which loan is better for borrowers Home Equity loan or a HELOC?  

The best loan can be a home equity loan if you want stability. If you prefer flexibility, HELOC is the best bet. 

5. What is HELOC?  

The Home Equity Line of Credit (HELOC) is offered based on home equity level with a pre-set credit limit, like a revolving credit.

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