It is easy to understand why people sometimes mix up HELOC and Home Equity Loans. They both have “home equity” in the title, and both are used as a way to pay for major projects, including renovation and home improvements. When borrowers want to use the equity they have in their homes to “cash out” or fund major projects, HELOC and Home Equity Loans are two of the common strategies that are recommended by financial advisors, bankers, bloggers, and more.
However, not all “home equity” strategies are the same.
HELOC and Home Equity Loans aren’t the same things at all! Understanding the differences between these two different programs will help you know which method, if either, is the right path for you to take to fund your next major project.
So, what is a Home Equity Loan?
A Home Equity Loan is what it sounds like: a loan that is borrowed against the equity you have in your home. Often, this is referred to as a “second mortgage,” because you essentially replace your original mortgage with a new one.
When applying for this kind of loan if you are approved, you will receive all of the money in one lump sum, which you can spend on just about anything you want. However, most borrowers responsibly use these funds to pay off debts or finance a major project that will increase the value of their home.
Some of the drawbacks of Home Equity Loans include:
- Paying closing costs
- Having to pay back the loan in full when you sell your home
- Risk of losing your home if you default on the loan
What about a HELOC?
HELOC stands for “Home Equity Line of Credit.” Instead of a loan, this is a credit line with a credit limit that is based on the amount of equity you have in your home. Typically, you can borrow up to 80% of the appraised value (sometimes higher) of your home, minus whatever you still owe. This makes a HELOC very popular with people who already have a significant amount of home equity.
One of the biggest differences between a loan and a line of credit is that a loan is given in a lump sum, whereas a line of credit allows you to withdraw what you need as you need it.
A HELOC has better interest than a credit card. Like a Home Equity Loan, you can use HELOC funds to pay for just about anything! Of course, just like a Home Equity Loan, a good financial advisor will recommend that you use this money for financial decisions with low financial risk, such as paying for home improvements, continuing education, consolidating debt, or financing a major life event.
Which type of loan is right for you?
Although we can’t answer that question with certainty in a blog post because everyone’s financial situation is different, we can provide you with some helpful guidance. (And you can always get in touch with us if you have questions or want to speak with one of our qualified mortgage specialists.)
Both loans are great for borrowers who:
- already have a good amount of equity in their home.
- have a home that will appraise well, especially if the appraisal value has gone up since the home was originally purchased.
- have a low debt-to-income ratio.
A HELOC also allows for more flexibility, because you can withdraw only the exact amount that you end up needing for your project.
Learn more in our new eGuide!
Our new eGuide, “Understanding & Using a HELOC to Finance Your Next Big Project,” offers more information on the ways that you can use a HELOC. Download it today and take a look to see if a HELOC is the right financial decision for you!