You own your home. You love your home. And, it’s probably the largest purchase you will make in your lifetime. You have the ability to tap into the equity you’ve built using two methods: a home equity line of credit (HELOC, pronounced HEE-lock) and a home equity loan (HELOAN).
Both HELOCs and HELOANs offer different ways to borrow money using your home as collateral. Though you are borrowing against your home’s equity with both options, the qualification requirements, costs, interest rates and repayment options vary greatly.
Look at both of your options in terms of different types of credit.
A HELOC line of credit serves as an open, more flexible form of credit. A line of credit often requires lower equity than a HELOAN. The amount of credit is determined by a formula in relation to a few moving pieces involving your built equity. Though there is a maximum withdrawal limit set, a HELOC is a revolving credit that allows a borrower to draw funds up to their set maximum. The Federal Reserve Board has provided the following formula as a rough outline of how HELOC limits are estimated:
Appraised value of home $100,000
Percentage x 75%
Percentage of appraised value $75,000
Less balance owed on mortgage -$40,000
Potential line of credit $35,000
The HELOAN is a closed, more rigid form of credit. Borrowers apply for a set amount and there is no revolving access to the money. It is distributed similarly to a tradition loan.
General qualifications for a home equity line of credit or loan are similar. Both require a credit check, home appraisal and a debt-to-income evaluation by the lender. A lender may judge earning potential and income stability based on input from your employer. Traditionally, a HELOC requires a lower equity for fund access than required by a home equity loan. A HELOAN requires, on average, 20% equity built in the home. Other requirements or minimums vary by financial institution.
If borrowing against your home’s equity is in your future, don’t forget to add in associated costs. Both home equity lines and loans do have closing cost associated with their origination. HELOC’s tend to have a yearly or monthly maintenance fee where your HELOAN does not incur any monthly fees beyond payment.
Interest Rate and Repayment
You may be surprised how interest rates and repayment play into selecting a line of credit or loan.
With a home equity loan, you will be paying predetermined interest (fixed or variable) the entirety of the loan. You will pay a fixed, monthly amount following a regular amortization schedule. This offers financial stability and regularity.
Here’s where one differentiator may be come into play. Unlike a HELOAN, a HELOC interest is calculated on a prime interest rate plus a margin. Often the interest rate may even be variable. Because the line of credit is revolving, a borrower is only required to make a minimum payment every month, which is often only interest. This could significantly change a borrower’s monthly payment over the payback period with the possibility of ballooning payments, or a lump sum due at the end of the payback period.
Paying the interest-only option may seem quite attractive in some situations. For instance, if you’re ready to pay off your mortgage in a few years, you can then dedicate what used to be your mortgage payment to paying off your HELOC.
Always keep in mind that the underlying collateral to a home equity finance option is your home. Defaulting on either one of these could put your home at risk for foreclosure so it is wise to make the right financial decision for your income statement.
If you need help deciding between a home equity loan and a home equity line of credit, stop in or call your local FNB Fox Valley branch.