If you’re a homeowner wanting to tap into your home’s equity, you might be considering a home equity loan or a home equity line of credit (HELOC). Both allow you to borrow against your home’s value, but they aren’t created equal. For example, a home equity loan pays out one big lump sum of money, while a HELOC offers you a revolving line of credit.
When you need to access the equity in your home, you have two options:
- Home equity loan
- Home equity line of credit (HELOC)
While both options sound similar and let you borrow against your home’s value, there are key differences between them that’ll determine which is right for you. Most notably:
Here is how home equity loans and HELOCs stack up against each other:
| Home equity loans | HELOCs | |
|---|---|---|
| Fund type | Loan | Revolving credit |
| Repayment | 5 to 30 years | Up to 25 years |
| Interest rate type | Fixed | Variable |
| Closing costs, points, and fees | Appraisal fees, origination fees, preparation fees, credit report fees, title search fees, and more. | Appraisal fees, application fees, points paid upfront, attorneys fees, title search fees, mortgage preparation fees, filing fees, title insurance, and more. |
| Best for | Those who need a lump sum of money to cover a big expense. | Those with continuous financing needs. |
Yes, you can get a home equity loan and a HELOC at the same time. According to Vikram Gupta, head of home equity at PNC Bank:
“One of the most critical factors to consider is your ability to make the additional monthly payments, and comfortably repay both loans, within the specified time frame without overextending yourself financially.” Gupta said. “It’s also important to consider the necessity of both loans and whether they truly align with your financial goals.”
A home equity loan lets you borrow against the equity that you’ve built up in your home. Great to help cover large expenses and financial emergencies, these loans pay one large lump sum upon approval.
You’ll need to pay back your loan in monthly payments with a fixed interest rate. The interest rate that you’ll pay depends on several factors, including your credit score, the amount of equity you’re borrowing against, and your loan amount.
To get a home equity loan, you’ll need to meet the qualifications set out by your lender. Each lender’s requirements are different, but usually include:
Once you’re sure you can qualify, the process is similar to getting a mortgage. You’ll start by comparing home equity loan lenders to find the one with the best rates and terms. Once you do, you’ll follow the lender’s application process and submit relevant financial documents.
There are no restrictions on what you can use home equity loans for. That said, borrowers tend to reserve them for large purchases and emergencies.
Some reasons why you might choose to take out a home equity loan include:
To figure out how much equity you have in your home, you can follow this simple formula:
Current home value – outstanding mortgage balance = home equity
For example, if your home is valued at $300,000 but you owe $200,000 on your mortgage, you have $100,000 in home equity.
It is important to note that many lenders have a maximum loan-to-value (LTV) ratio that they’re willing to loan you, which typically falls around 85% of your home’s value. Additionally, you should be aware that your equity will fluctuate depending on the value of your home in the current housing market.
A home equity line of credit (HELOC) lets you borrow against the equity you’ve built in your home. Unlike home equity loans, which pay out a lump sum, HELOCs offer a revolving line of credit that stays open for a period of time, often referred to as a “draw period.” Typically, draw periods last up to 10 years.
During the draw period, you can withdraw funds as needed, up to your credit limit. Then, when the draw period ends, you’ll pay back your balance plus interest. On a HELOC, interest rates are usually variable and are based on the prime rate, plus an additional margin determined by your credit score and history.
To get a HELOC, you’ll need to start by meeting the requirements set out by your lender. Each lender is different, but most usually require:
After you’re sure you can qualify for a HELOC, the process will be very similar to applying for a home equity loan.
HELOCs are flexible and convenient, making them a good option if you’re in search of funding. Here are some reasons why you might consider a HELOC:
Like with home equity loans, HELOC lenders have a maximum loan-to-value ratio cap. For HELOCs, this is usually set at 75% to 85%. With that in mind, lenders calculate your tappable equity by using the following formula:
(home value x lender’s loan-to-value ratio cap) – outstanding mortgage balance = tappable equity
For example, let’s say that your home is worth $400,000, your lender’s maximum LTV for a HELOC is 80%, and your outstanding mortgage balance is $200,000. Using the above formula, you’d have $120,000 in tappable equity.
Home equity loans and HELOCs aren’t the only options if you’re looking for funding. Alternatively, you might consider: