HELOC vs. Home Equity Loans: A Comparison
Since home prices have gone up over the past few years, many people now have more equity than ever. If you’re one of them, you may be wondering how to use it to pay for something useful, like a big project or taking care of other debts.
You can use a Home Equity Line of Credit (HELOC) or a home equity loan, to get the most out of the value of your house. We'll talk about both of them, their benefits, and the main differences between them so you can make an informed decision on which one best meets your personal finance needs.
If you're ready to leverage your home’s value, Rate offers an easy HELOC application process that can help you take the next step.
What Is a HELOC and How Does a HELOC Work?
A Home Equity Line of Credit (HELOC), lets you borrow money over and over again based on the amount of equity you've built in your home like a revolving line of credit.
It gives you flexible access to funds, unlike traditional home loans that give you a single lump sum. This makes it perfect for covering ongoing costs like home improvements, school costs, high medical bills or even settling high-interest credit card debt.
You can take out money as needed during your "draw period," which with a HELOC usually lasts between 5 and 10 years. Monthly bills are low, since you might only have to pay interest during this time.
After the draw period is over, you'll have the repayment period where you’ll have to pay back the loan amount plus interest over a set period of time, normally 10 to 20 years.
What Is a Home Equity Loan?
A home equity loan allows you to borrow a lump sum based on the equity you've built up in your home. It’s also known as a "second mortgage." This type of loan gives you a set amount of money upfront similar to a cash-out refinance, which you then pay back over a set term with regular monthly payments.
A home equity loan is better than a HELOC if you need a set amount of money as a one-time payment, like school costs, a big home renovation, or consolidating your personal loan debt.
Another great thing about a home equity loan is that the interest rate usually comes under fixed-rate loans, which means your loan payments stays the same over time. This means that your monthly payments will stay the same, which gives you predictability when it comes to planning your finances.
HELOC vs. Home Equity Loan (Pros and Cons)
Pros of HELOC
- Flexible access to funds when needed
- Interest-only payments during the draw period
- Can be used for ongoing expenses or variable projects
- Typically lower initial payments compared to loans with fixed rates
Cons of HELOC
- Variable interest rates can lead to fluctuating payments
- Risk of overspending due to access to revolving credit which can ultimately lead to a foreclosure if you’re not careful
Pros of a Home Equity Loan
- Fixed interest rates for stable, predictable payments
- Consistent monthly payments make budgeting easier
- One-time lump sum can be used for large, planned expenses
- Ideal for people who want a straightforward fixed monthly payments
Cons of a Home Equity Loan
- Less flexibility; can’t borrow more once the loan is disbursed
- Closing costs and fees similar to your original mortgage
Common HELOC and Home Equity Loan Requirements
Here are some of the most common requirements:
Home Equity Amount and Loan-to-Value (LTV) Ratio
Home equity and your loan-to-value ratio (LTV) are key factors when applying for a HELOC or a home equity loan. Your LTV ratio is calculated by dividing your current mortgage balance by your home's market value, then multiplying by 100 to get a percentage. For example, if your home is worth $400,000 and you owe $280,000, your LTV is 70%.
Most lenders want you to have about 20% equity in your home, which means that your LTV should be 80% or less of the home's market value. The more equity you have, the better terms you might qualify for like lower interest rates or a higher credit limit.
Understanding your home equity and LTV not only helps you meet lender requirements but also supports better financial planning by ensuring you have enough equity for future needs or resale value.
Minimum Credit Score
A good credit score shows lenders that you'll be a responsible credit holder who pays back their loan on time, which is a must for approval.
Most lenders also require you to have a credit score of at least 620, but if you have a higher score, you might be able to get better mortgage rates.
Income Verification
Lenders want to see proof of a steady income to make sure you can make your monthly mortgage payments. Most of the time, this means showing recent pay stubs, tax records, or other proof of income that backs your financial situation.
Acceptable Debt-to-Income Ratio
The debt-to-income (DTI) ratio tells you how much of your monthly income goes toward paying off debt. Usually, it should be 43% or less.
This ratio helps lenders figure out if you can properly take on more debt without going overboard. A smaller DTI means you have enough extra income to handle a new loan on top of your “first mortgage”, which raises your chances of being approved.
How to Get a HELOC or Home Equity Loan
The process to getting a home equity loan or a home equity line of credit (HELOC) is straightforward, especially with Rate’s streamlined application process. By following these steps, you can secure the funds you need with ease:
Look at Rates, Terms, and Fees
The first step is to compare lower rates, terms, and fees across different lenders to find the credit line option that works best for your budget and goals. Pay close attention to interest rates, whether fixed or variable, as well as any hidden fees like closing costs or annual fees.
Rate provides competitive rates and clear information about our HELOC and home equity loan options, making sure you get transparency every step of the way.
Get the Necessary Documentation
Preparation is key to a smooth application process for homeowners. Commonly required documents include:
- Proof of Income: Recent pay stubs, tax returns, or other income records.
- Mortgage Information: Your current mortgage statement showing the outstanding balance.
- Property Details: Information about your home’s value and any liens.
- Identification: A government-issued ID for verification purposes.
Having these documents ready will make the application process faster and hassle-free.
Start Your Application with Rate
Once you’ve done your research and gathered your documents, it’s time to apply. Rate offers a fully digital application process, making it quick and convenient.
All you need to do is visit our website, complete the online application by providing your personal, financial, and property details, and upload your supporting documents directly through our platform.
How to Determine Which Is Right for You
Which one should you choose? Let's break it down.
Consider Your Financial Goals
How are you going to spend the money? A HELOC might be a better choice if you need to be flexible with ongoing costs, like making real estate home improvements or paying for several projects over time.
You can get your money when you need it, which is great for costs that you can't predict.
A home equity loan, on the other hand, might be better if you only need the money for one thing, like a big renovation or paying off other debt.
You get a lump sum up front and have a set amount of time to pay it back in monthly installments. This helps you stay on track with your finances by giving you a clear plan.
Evaluate Your Budget and Cash Flow
If you're okay with the idea of changeable payments and interest rates going up and down, a HELOC might be a good choice for you. People who have a steady flow of cash and are ready for changes in their monthly payments may find these features useful.
But if you like knowing exactly how much you'll have to pay each month, a home equity loan might be better for you. You'll know exactly what to expect each month with a set rate, which can make things easier to handle if you're on a tight budget.
Assess Interest Rate Preferences
Interest rates can change a lot over time. Most HELOCs have changeable rates, which means that you may experience higher interest rates and your monthly payments may go up as the market changes.
A home equity loan might be a better choice for you if you'd rather lock in a set rate to avoid surprises and keep your payments stable. A set rate gives you more security, which can help you plan your budget for long-term costs.
How do repayment terms differ between a HELOC and a home equity loan?
Plan out how you'll pay back the loan. Most of the time, a HELOC starts with interest-only payments. This can be helpful in the short term, especially if you think your cash flow will change.
But keep in mind that this doesn't lower your principal amount. You'll have to pay back the capital at some point, and your payments will go up to reflect that.
With set monthly payments, a home equity loan can help you be more financially stable. It may be a better choice if you want stable payments for the life of the loan.
Your Next Step
If you want to get a home equity loan or a home equity line of credit, you should think about your financial goals and whether you would rather have flexible or set payments.
Getting money from the value of your home can help you pay for big costs like home improvements, debt consolidation, or other big purchases.
When you're ready, look into Rate's HELOC application process to quickly and easily get the money you need for your home. It's an easy thing you can do to reach your cash goals.