A home equity line of credit (HELOC) and home equity loan are great ways to use your home's equity. Tapping into your home's equity can allow you to pay for experiences or improvements with a lower-interest method.
But which method is the best way for you? Our lending experts explain the difference between HELOCs and home equity loans below:
What is a Home Equity Line of Credit?
A home equity line of credit, or HELOC, is a type of home equity loan. It uses a line of credit, allowing you to borrow money while using your home’s equity as collateral. HELOCs typically have low and variable interest rates. They also provide flexibility in using the funds and repayment period.
HELOC’s credit limit is contingent on the amount of equity in your home. So, the more equity you have, the higher your credit limit. HELOCs also provides homeowners the opportunity to borrow the exact amount needed.
How does a HELOC work?
As the name implies, HELOCs act like credit cards. They have a credit limit based on the loan-to-value percentage set by the lender. The loan-to-value rate is the ratio between the amount owed on your home versus its actual worth.
The borrowed amount is paid back, including any interest accrued. This method provides flexibility where you can withdraw funds, pay the amount back, and withdraw again.
There is usually a withdrawal and repayment period with a HELOC. Withdrawal periods vary but typically range between 5-10 years. You’re required to pay the loan’s interest during the withdrawal period. Should you need to renew your credit line, talk to your lender.
Repayment periods range from 10-20 years. You’re required to repay interest during the repayment period, including the amount used. Also, interest accrues only on the loan amount used, not the total amount borrowed. For example, if you only used 10,000 out of a limit of $30,000, you’re only required to pay interest on the $10,000.
What is a Home Equity Loan?
Home equity loans have several names, including an equity loan, home equity installment loan, or even a second mortgage. Regardless of the term you use, its main objective is the same as a HELOC: it uses your home’s equity as collateral to borrow money.
Unlike a HELOC, home equity loans allow the borrower to extract a lump sum of funds. Similar to a mortgage, this loan has costs and fees. It may require you to pay these fees upfront.
How a Home Equity Loan Works
Home equity loans act as a second mortgage with fixed monthly payments. Like a HELOC, the lump sum borrowed is also determined by the loan-to-value percentage.
Unlike a HELOC, there is no withdrawal period for a home equity loan as you borrow a lump sum. However, there is a repayment period. Loan terms range from 5-to 30 years, but repayment begins when the funds are dispersed.
Examples of approval requirements for a home equity loan or HELOC
Approval requirements vary by lender, so speaking to a trusted lender is always encouraged. However, approval requirements for a home equity loan or HELOC are very similar.
The Amount of Equity
As previously stated, the credit limit of a HELOC is determined by the loan-to-value percentage. It is the same with home equity loans. This percentage is the amount of equity in your home. Having at least 20% of the equity in your home increases your chances of being approved.
Lenders also look at your credit score to prove how trustworthy you are in paying back the loan. Lenders may require a credit score in the mid-600s. Having a credit score of at least 700 provided a solid foundation.
Debt to Income Ratio
Your debt to income (DTI) ratio is determined by the amount of debt you have compared to your monthly income. Like any other loan application, lenders look to this DTI to assess the amount of risk they’re taking by borrowing you money.
Typically lenders are looking at a DTI of less than 36%. However, if you have a higher credit score and more equity, your chance of approval may increase.
What can you use them for?
Home equity loans and HELOCs can be used for various reasons because they are secured and supported by your home’s equity. They can be used for vacations, recreational vehicles, home improvements, and consolidating high-interest debt.
Regardless of use, we encourage you to speak to a trusted lender to help you navigate between HELOCs and home equity loans. Contact CSB today to speak to one of our lenders!
Disclaimer: All information provided within this blog is for educational purposes only and may not be used as legal, business, or official financial advice. To speak to our Cleveland State Bank lending team, contact them today!