HELOC vs. Home Equity Loan
There are many advantages to owning a home, and among them is the ability to take advantage of its equity.
Home equity is the amount of money, or value, of the home that belongs to you based on what you still owe on your mortgage. Your home equity can be calculated by taking the total value of your home and subtracting the amount of money you still owe on your home loan. Whatever amount remains is the amount of equity you have in the home.
A Home Equity Line of Credit (HELOC) and a Home Equity Loan are two types of secured loans. A secured loan requires that the borrower put up a security or collateral (in this case the borrower’s home) to secure the loan. If the loan is not paid back, the lender can take possession of the home through the foreclosure process.
But what is the difference between a home equity loan and a line of credit? Although similar, HELOCs and Home Equity Loans have some key differences when it comes to utilizing home equity.
A HELOC grants homeowners access to a certain amount of money during a draw period and typically has a variable interest rate that’s charged only against the amount of money that’s withdrawn.
A home equity loan provides the loan amount to the borrower in a lump sum, which they then need to pay interest against. Most home equity loans have a fixed interest rate that’s charged on the entire lump sum amount, but home loans are also available with variable interest rates as well.
At Credit Union of Southern California (CU SoCal), we make getting
a Home Equity Line of Credit or Home Equity Loan easier.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our
home equity lines of credit,
auto loans,
personal loans,
checking and
savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all of your banking needs.
Get Started on Your Home Equity Line of Credit (HELOC)
Understanding Equity
Home equity is the dollar portion of the home that you own based on how much you owe on your mortgage and any other secured loans that use the house as collateral.
For example, if you
do not have a mortgage on your home then you have 100 percent equity in the home. People who have a mortgage own only a percentage of the home (the lender who holds the mortgage also owns a percentage of the home).
As you pay down your mortgage your equity increases until the mortgage is paid in full and you have 100 percent equity.
To calculate equity, take the amount your property is currently worth, or the appraised value, and subtract the amount of any existing mortgage on your property.
For example:
Appraised value is $600,000 – Amount owed on mortgage is $250,000 = $350,000 Equity
What Is A HELOC?
Having equity in your home is a good thing! The more equity you have, the more money you can borrow in the form of a Home Equity Line of Credit (HELOC) or a Home Equity Loan.
HELOCs are offered by credit unions, banks, mortgage companies, and some online lenders. Each lender has a unique set of qualifying requirements that a borrower must meet to be approved for the loan in the first place, and then the amount of money that you can borrow will be determined based on several financial factors that we’ll explain below.
Here are some general HELOC requirements:
- A minimum credit score of 660.
- Proof of income and employment.
- A new appraisal to determine the current value of your home.
- Up to 85% Loan-to-Value (LTV)
To learn more read, “
What is a HELOC.”
HELOC Pros and Cons
Pros:
Low APR: While most HELOCs come with an adjustable interest rate, the Annual Percentage Rate (APR) on a HELOC is typically lower than the interest rate charged by credit cards on purchases and cash advances.
Interest May Be Tax Deductible: According to the
IRS, the interest paid on home equity loans and lines of credit is only deductible when you use the proceeds to buy, build, or substantially improve your home that secures the loan.
For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
Get more information from the IRS.
Borrow Only What You Need: Having a line of credit means you can borrow only the amount you need by withdrawing it from your HELOC account using a check or ATM card. You will only pay interest on the amount you borrow, not the full amount you are approved for.
Flexible Repayment Options: All HELOCS have a “draw period” (typically 10 years) and a “repayment period” (typically up to 20 years). During the draw period, you can borrow as much of the funds as you need. Payments made during the draw period are “interest only,” meaning you aren’t repaying the loan with principal. Some lenders will allow payments toward principal during the draw period. Be sure to ask your lender about repayment terms.
Raise Your Credit Score: Making on-time loan payments will boost your credit score. Adding a HELOC to your credit mix can boost your
FICO score in two ways: by adding to your Credit History (which accounts for 35% of your credit score) and adding to your Credit Mix (which accounts for 10% of your credit score).
Pre-Payment Penalty: Most HELOCs do not have a pre-payment penalty. As you shop for a HELOC, be sure to ask each lender about pre-payment terms. Some may require you to keep the loan open for a fixed period of time
Few Restrictions: You can use the money any way you’d like!
Cons:
Your Home Will Be Used As Collateral: If you default on the loan, the lender can do a foreclosure and you could lose your home. Failure to make on-time payments will also hurt your credit score.
Variable Interest Rate: HELOCs often come with a low promotional rate, and when the promotional rate expires, they have a variable rate that can increase over time. A variable interest rate means the amount you owe in interest on the amount you’ve used will be different each month. If your financial situation worsens during the loan period, you could end up owing more than you are able to pay.
Overspending: Because the money is available, many people will borrow from it freely and run the risk of using more funds than originally planned. The draw period’s interest-only payments make repayment appear manageable, but eventually the principal amount will need to be paid back.
Reduced Equity In Your Home: Using your home as collateral means you have less equity. This could affect your ability to get approved for other loans while you have an open HELOC.
What Is A Home Equity Loan?
Often referred to as a “second mortgage,” a home equity loan is a big financial responsibility. When someone takes out a home equity loan, they are getting a large lump sum of cash based on the equity in their home.
Interest on the full amount will need to be paid each month, whether or not you actually use any of the funds. Unlike a HELOC, which requires that you only pay interest on the portion you use, a home equity loan requires monthly payments for as long as you have the loan.
Home Equity Loan Pros And Cons
Pros:
Lump Sum: For people in need of a large sum of money to renovate a home or purchase an investment property or second home, a lump sum distribution can set the stage for making a cash purchase.
Fixed Interest Rates: A fixed interest rate means a predictable monthly payment amount for the life of the loan, so you can budget for the expense of paying back the loan.
Interest May Be Tax Deductible: According to the
IRS, interest paid on home equity loans and lines of credit is only deductible when you use the proceeds to buy, build, or substantially improve your home that secures the loan.
For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
Get more information from the IRS.
Cons:
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan.
Your Home Will Be Used As Collateral: If you default on the loan, the lender can take possession of the home through a foreclosure. Failure to make on-time monthly payments will also hurt your credit score.
Closing Costs: Most home equity loans have closing fees, which may include an application fee, appraisal fee, processing fee, and others.
Pre-Payment Penalty: Home equity loans typically have a pre-payment penalty.
Two Mortgage Payments: Whether or not you use the money given to you in a home equity loan, the lender will expect you to pay monthly interest on the total loan amount. If you have used any part of the loan, your monthly payment will include interest and principal.
How To Choose Between A HELOC and A Home Equity Loan
Which is better, a home equity loan or line of credit? When deciding between a HELOC and a home equity loan, here are some points to consider.
In general, a home equity loan is better suited for borrowers who need a lump sum of cash to make home renovations or purchase an investment property or second home. With a home equity loan, be prepared to start paying interest on the full loan amount right away.
A HELOC is good for borrowers who may need money for pay-as-you-go situations and financial needs including paying off or paying down high interest credit card debt, paying for college tuition, making gradual home renovations, planning a wedding, and starting a business.
Whether you choose a HELOC or home equity loan, both have their pros and cons. Each individual must decide how much money they need, when they need it, and if they have the employment and income stability needed to repay the funds.
HELOC and Home Equity Loan Alternatives
If a HELOC isn’t right for you, consider these other loan options:
Cash-Out Refinance: With mortgage interest rates very low, refinancing your current mortgage to get a new mortgage loan with a lower interest rate could help you lower your monthly payments. Getting cash-out means borrowing more than what you owe on your current mortgage and getting a cash disbursement of the extra funds at closing. You can use the cash any way you choose.
Personal Loans: Credit unions and banks offer a wide variety of
secured and unsecured personal loans, to meet a wide variety of borrowing needs. You’ll find variable and fixed rate
personal loan options.
Family Loans: You may have family members that are willing to loan you the money you need; however, this type of loan can damage the relationship if you fail to pay back the money. If you borrow money from a family member, always put in writing what the re-payment terms will be.
0% APR Credit Cards: There are many credit cards that offer a promotional 0% APR (annual percentage rate) for a fixed period, usually 12 months. After the promotional rate expires there will be a new higher rate applied to the outstanding balance, so be sure you know what the post-promotional rate will be. This option can be good if you need extra money in the short term.
CD Loan: A CD is a Certificate of Deposit — a type of savings account offered by credit unions and banks. This type of loan uses your CD account as collateral. The lender will add a small percentage interest fee to the CD’s APY (annual percentage yield) to come up with the amount you will be charged to borrow money using your CD as collateral.
CU SoCal HELOC
CU SoCal offers an interest-only HELOC, so you pay only the interest due each month, giving you the flexibility to keep payments low during the 10-year draw period of your loan. We offer the choice of either a lump-sum loan or a revolving credit line that can be used over and over again.
Other great HELOC features include:
- Access up to 80% of your home's equity.
- No points.
- No appraisal fees for single unit loans.
- No annual fee.
- No closing costs.
- Loan limit up to $250,000.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including
HELOCs,
car loans,
personal loans,
mortgages,
credit cards, and other banking products, to those who live, work, worship, or attend school in
Orange County,
Los Angeles County,
Riverside County, and
San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit (HELOC)