What Is the Difference Between a Line of Credit and Home Equity?
Home equity loans have significantly increased in popularity in the past few years. In fact, a recent article from USA Today stated that homeowners have an estimated $20 trillion worth of home equity. This alone has significantly boosted the demand for home equity loans and home equity lines of credit (HELOCs). But what do HELOCs and home equity loans do? And what makes these options different from other mortgage loans?
At a high level, a home equity loan allows you to borrow a lump sum of money against the equity of your house. Home equity loans function similarly to traditional loans where the amount borrowed is presented as a one-time cash payout. Additionally, you are responsible for completing regular payments throughout a fixed repayment time frame, which ranges from five to 30 years.
So, how does a home equity line of credit work? Unlike home equity loans, HELOCs function similarly to credit cards and provide revolving lines of credit. Revolving lines of credit enable you to borrow money more than once throughout a specified draw period. Regarding repayment, HELOCs typically allot 10 years to take out funds, and 20 years to repay what was borrowed. IMCU offers a variety of options including 30 and 40-year lines of credits, and interest only lines of credit. Details about these specific programs can be found here.
With either option, the final amount you are allowed to borrow depends on the appraised value of your home and the equity you currently have available.
HELOC and Home Equity Requirements
Home equity loan and home equity line of credit requirements are the same. To qualify for either option, you must have:
- A good credit score. 640 or more falls within the acceptable range.
- A low debt-to-income ratio. 50% or lower with 95% CLTV is ideal
- Home equity of 15% or higher.
When Is It a Good Idea To Have a HELOC?
The answer to this question depends on your specific circumstances. If you need to fund improvements to your home and increase its resale value, then pursuing a HELOC will likely be advantageous. However, there are certain situations where using a HELOC may not be the best course of action. For example, using HELOCs to purchase a car or pay for a vacation could cause you to accrue unnecessary bad debt.
To learn more about HELOCs and how to use them to your advantage, review Indiana Members Credit Union’s (IMCU) comprehensive breakdown.
Do HELOCs Have Higher Rates?
Most HELOC rates are variable, but some lenders do offer a fixed-rate HELOC option. Fixed-rate HELOCs provide initially higher rates with more predictable monthly payments. Variable rates offer initially lower interest rates that fluctuate over time. Additionally, variable rates offer shorter payoff periods than fixed-rate HELOCs. Currently, IMCU offers 7.75% APR for a 30-year HELOC. As for home equity loans, IMCU offers 6.199% APR for a first lien five-year loan term.
Should You Pursue a HELOC or a Home Equity Loan?
In the end, both options allow you to borrow against the appraised value of your home and offer the cash you need. If you have a specific amount in mind and only require a one-time payout, a home equity loan might be the better option. However, if you need more flexibility, HELOCs allow you to access the funds you need on an ongoing basis.
It’s also important to recognize that your home is being treated as collateral with either option. If your financial circumstances take a sudden and unfortunate turn, or if the overall value of your home decreases, you could be putting yourself at risk. However, if your financial situation is largely stable and your debts are fairly limited, pursuing a HELOC or a home equity loan could be a worthwhile investment.