When it comes to the financial tools in your toolbox, your home may be one of the most advantageous resources to bolster your net worth and achieve your goals. Financial institutions offer specific loan types – including a Home Equity Line of Credit (HELOC) and a home equity loan – that allow you to use the equity you have in your home to fund other expenses and aspirations.
Understanding the pros and cons of a HELOC versus home equity loan can help you choose the best option for your specific needs.
You’ll notice that these two loan types share the same key phrase: home equity. Your home equity value equals how much of your house you financially own. It’s calculated by taking your home’s current market value and subtracting your remaining mortgage balance from it.
Example Home Equity Calculation
Your home is valued at $500,000, yet you owe $100,000 before your mortgage is paid off. You have $400,000 in home equity, which can be leveraged through a HELOC or home equity loan.
A HELOC uses your home equity value to fund a revolving line of credit that you can use, as needed, for different types of expenses.
HELOCs are made up of two periods: a draw period and a repayment period. During the draw period, you can make multiple withdrawals (up to your available credit limit), pay down the debt, and then withdraw again before the draw period ends. Your monthly payment will typically only reflect the interest on your borrowed amount.
Once the repayment period begins, however, you will no longer be able to make withdrawals from the HELOC and you’ll be responsible for repaying both the amount borrowed and its associated interest.
HELOCs are commonly offered with a variable rate that is tied to the Federal Reserve’s federal funds rate, meaning your interest rate can fluctuate based on market conditions. Some lenders also offer fixed rate HELOCs with a locked-in rate. It’s wise to inquire with your lender to see what options are available.
Flexibility to borrow only what you need.
You only pay interest on the borrowed amount.
Typically offer better interest rates than credit cards because they’re secured by your house.
If you have a variable rate and interest rates increase, so will your monthly payment.
You could lose your house if spending goes unchecked and you’re unable to repay the debt.
A home equity loan converts the equity in your home into a one-time lump sum of money that you’re required to pay back in monthly installments. A home equity loan usually has a fixed rate, meaning your monthly payment remains the same over the life of your loan.
If market conditions worsen, your interest rate is unaffected because it’s a fixed-rate loan.
Your monthly payment will be the same every month.
Typically offer better rates than personal loans because they’re secured by your house.
If your home value decreases, you may then be upside down in your mortgage and end up owing more than your home is worth.
It’s easy to over-borrow with a lump sum cash disbursement, and you’ll still be responsible for paying the entire amount back.
May have closing costs and fees higher than those of a HELOC.
Both loan types can be used to fund home renovations, medical costs, emergency funds, and other expenses, but they’re not the same. Deciding between a HELOC and home equity loan is dependent upon your personal situation.
A home equity loan is dispersed as a lump sum with a pre-determined term and fixed rate, meaning you’ll be responsible for paying back the entire loan amount in equal monthly installments. If you have a specific expense in mind or want to know what your exact monthly payment will be, consider a home equity loan.
A HELOC allows you to draw from an available amount as often as needed during the draw period, and your monthly payments can fluctuate because your interest rate is tied to current market conditions. If you have project-based or ongoing expenses and aren’t sure how much you’ll need to cover your costs, or you’re comfortable with a changing monthly payment, a HELOC might make more sense.
When speaking with potential lenders to compare rates, be inquisitive and ensure you fully understand their terms – they may have fees and specific repayment structures that could also influence your decision.
Regardless of whether you choose a HELOC or home equity loan, remember that your house is the collateral that secures the loan. Like all things in life, this offers benefit and risk: The benefit is that your interest rate will typically be lower in comparison to unsecured personal loans or credit cards; however, it is possible that you may lose your home if you fail to make payments and default on the loan.
Peak Credit Union’s ChoiceLine Home Equity Line of Credit offers credit lines for up to 100% of your home’s value to help you bring your dreams to life. The best part of our ChoiceLine Home Equity Line of Credit is your ability to customize it to fit your lifestyle. Choose to draw on a variable rate line of credit whenever you need or lock in part – or all – of the outstanding balance at a fixed rate and term.
It's easy to get started. Apply online now, visit any of our branches, or give us a call at (800) 258-3115.