If you own a home and are in need of a loan, you might be able to use the equity that’s built up in your property to be put towards a large expense.
Home equity loans and home equity lines of credit (HELOCs) allow homeowners with a certain amount of equity in their homes to use some of that equity as a loan. If you have some sort of pressing expense that requires a lump sum of money to cover, one of these two loan options may be able to help.
If you make regular mortgage payments or if your property increases in value over time, your home equity will increase. If you have a certain amount of home equity amount built up, you may qualify for a home equity loan or HELOC. In both of these situations, the amount of equity that you borrow will be added to the existing mortgage debt.
But while both of these loan products involve pulling out equity from your home to be used towards a large expense, they’re not exactly the same. Let’s go over what a home equity loan and a HELOC are and compare them to see how they’re similar to each other, as well as how they differ.
Home Equity Loans Explained
A home equity loan is similar to other types of loans in that you’re given a lump sum of money after your loan application is approved. You’ll be given a specific time frame within which to pay back the loan in full by making regular loan payments. Like other types of loans, you’ll also be charged an interest rate which will determine how much you’ll have to repay in total.
This type of loan allows the borrower to use the equity of the home as collateral. The funds borrowed will depend on the value of the home, which will be determined by an appraiser appointed by the lender. Since the loaned funds are secured by your home, a home equity loan can be easier to qualify for compared to other loan types.
Home Equity Lines of Credit (HELOCs) Explained
A HELOC allows you to borrow against the equity in your home, as is the case with a home equity loan. But rather than serving as a traditional type of loan, this type of financing works similarly to a credit card.
The lender will allow a maximum amount to be borrowed within an agreed-upon time frame referred to as the “term.” Within this term, you can borrow as much or as little of that credit limit as you like – much like a credit card – as long as you don’t withdraw more than the maximum amount allotted.
You can make your principal payments any time you like and will only be charged interest on the amount withdrawn rather than the entire credit limit amount. If you don’t borrow anything against the credit limit, you won’t have any interest to pay. Only when funds are withdrawn will you be charged interest.
To repay the funds, you can choose to make regular monthly payments or transfer funds from your bank account whenever you have extra money to put towards your HELOC. You can either choose an “interest-only” draw period whereby you only pay interest on the funds withdrawn or a principal-and-interest draw period to help you pay your loan off faster.
When you pay back the amount that you withdrew, you’re free to use it over again as your credit revolves. When the end date of your line of credit hits, you then enter the repayment period that can last for years. Any outstanding balance borrowed will have to be repaid along with any interest owed. You can then renew your credit line if you need to, as long as your lender agrees.
How Can You Qualify For a Home Equity Loan or HELOC?
In order to qualify for a home equity loan or a HELOC, your lender will want to make sure you’re financially sound, similar to when applying for your first mortgage. But not only that, your lender will want to make sure that you’ve got enough equity built up in your home.
Generally speaking, homeowners must own at least 20% of the home – including after the additional equity has been withdrawn – before being eligible for either one of these two loan options. That means your mortgage can’t be any more than 80% of the value of your home.
The Bottom Line
Both a home equity loan and a HELOC can come in handy when you need money to cover any one of life’s big expenses. But which one is best for you?
If you need a lump sum of money for a one-time expense and have no plans to borrow any time in the near future after that, then a home equity loan might be best. But if you think you’ll need access to cash a few times over the next little while, then a HELOC might be more convenient for you. Just make sure you’ve got the finances needed to make payments in order to protect your collateral.