Pros
- Flexible funding: Helocs let you use the money for various purposes and draw on the line of credit as needed rather than getting a single lump sum.
- Lower interest rates: Helocs often have lower interest rates than personal loans or credit cards, so they are a more affordable option. Plus, you only pay interest during the draw period, so if you don’t have a balance, you don’t pay anything.
- Potential tax benefit: The interest you pay on a Heloc for the portion used for home improvements might be eligible for a tax deduction.
Cons
- Variable interest rate: Most Helocs have variable rates, so your payments can increase if interest rates rise, making it harder to plan your monthly budget.
- Closing costs: Like a home equity loan, a home equity line of credit often comes with closing costs and other potential fees, increasing your overall cost of borrowing.
- Risk of losing your home: A Heloc is secured with your home’s equity, meaning you could lose your house if you can’t make payments on your line of credit.
Deciding factors
Whether you choose a Heloc vs. home equity loan depends on your financial goals.
Use a Heloc if:
- You’re not sure how much you need to borrow and want flexibility to access more funds without reapplying.
- You plan to access the money over time instead of all at once.
- You want the Heloc available if needed, but might not draw on the line of credit immediately.
Use a home equity loan if:
- You know how much you want to borrow, and you’re reasonably sure you won’t need additional funds.
- You want the stability of regular, fixed payments for a pre-determined period of time.
Differences between Helocs and home equity loans
Both Helocs and home equity loans are based on the value you’ve built up in your home. A Heloc is a subset of home equity loan. Here are some of the major differences between the two:
- A Heloc is a line of credit while a home equity loan is generally disbursed in a lump sum.
- Helocs allow you to continue drawing on the credit line, up to your available balance, without the need to reapply for funds. If you want additional funds with a home equity loan, you generally need to apply for a new loan.
- Repayment on a home equity loan typically begins immediately, while you’re normally required to only pay interest on a Heloc during the initial draw period. After the draw period on a Heloc, you begin making regular payments.
- Interest rates on a home equity loan are generally fixed, while Helocs usually have variable rates. Once the draw period is over, though, some lenders allow you to convert a portion of your Heloc to a fixed rate.
Requirements for a Heloc or home equity loan
When applying for any loan based on the equity in your home, you generally need to have adequate value available. For example, a lender might allow you to borrow an amount that brings your combined loan-to-value (CLTV) ratio up to 80%. This means that you need to have built up enough equity so that your new home equity loan or Heloc, when added to your existing mortgage, doesn’t exceed 80% of your home’s value.
Let’s say you owe $230,000 on your home. However, it’s worth $325,000. The difference between what you owe and what your home is worth — your equity — is $95,000. If the lender allows an 80% CLTV, you can bring your total debt up to $260,000 (80% of $325,000). You can borrow up to $30,000 ($260,000 – $230,000) using this formula.
Some lenders allow a 90% or 95% CLTV, which could lead to a higher amount of available equity. However, it’s important to note that you aren’t usually able to access your entire equity.
In addition to adequate equity in your home, lenders also usually require that you have good credit and stable income. You typically need to show that you’re likely to make regular on-time payments. As with any loan, your credit history, income and term length influence your approval chances and your interest rate.
FAQ
Are interest rates higher on Helocs or home equity loans?
Helocs typically have lower initial interest rates than fixed-rate home equity loans. However, over time, if interest rates rise, a Heloc could end up with a higher interest rate than a home equity loan. As of May 28, the average Heloc APR is 8.14%, while a 15-year home equity loan rate is 8.32%.
How does repayment differ between a Heloc and a home equity loan?
Repayment on a Heloc usually only requires interest payments during the draw period, while repayment on a home equity loan usually begins immediately after you receive the funds.
Can I use a Heloc or home equity loan for investment purposes?
You can typically use the money from both home equity borrowing options for any purpose, including investing.
What are the tax implications of a Heloc versus a home equity loan?
Loans aren’t usually considered income for tax purposes. However, with both Helocs and home equity loans, you might be able to deduct the interest you pay if the funds are used for home improvements.
