As a homeowner, you stand to make a substantial profit when you sell your house. But while you’re living in the property, you’re likely sitting on a large amount of equity that remains out of reach unless you use a home equity loan or home equity line of credit (HELOC) to unlock it. Understanding the benefits and potential downsides of each is crucial.
Difference between a HELOC and a home equity loan
Both home equity loans and HELOCs use your home as collateral. If you default on your payments, the lender will be legally entitled to foreclose on your home. However, there are significant differences between the two.
A home equity loan works similarly to a standard loan. You receive a lump sum that needs to be repaid in regular payments with a fixed interest rate; it usually lasts five to 20 years and is typically limited to 80% of your equity. A home equity loan is often used for major home repairs or renovations, such as remodeling or adding new rooms, and debt consolidation.
A traditional HELOC enables you to draw up to the max loan amount for an extended period of time, typically around ten years. This allows you to borrow money for recurring, difficult-to-predict expenses such as a significant home renovation consisting of multiple projects with varying costs. The HELOC allows you to pay these expenses without knowing the exact price in advance, and can be repaid by making the minimum monthly payment or in one lump sum.
Pros of a home equity loan
Lenders grant home equity loans, also known as equity loans or home equity installment loans, at a fixed-term rate based on the equity in your home. They are often second mortgages and you apply for a set amount of money that, if approved, is received in a single upfront payment.
The benefits of choosing a home equity loan include:
Lump sum payment
Receiving a one-time lump sum payment enables you to borrow a significant amount of cash. This is ideal if you have a single expense you need to put aside a large amount of money towards, such as a home repair project, a down payment on another property or a car, or college tuition. However, in the event you need more money for an emergency, you would have to apply for another loan.
Not revolving credit
A home equity loan enables you to receive all the loan proceeds at once, guaranteeing you a specific amount of money to borrow and a set monthly payment. With a HELOC, however, the amount of money borrowed is revolving, which means your minimum payments can also change if you draw additional amounts.
Single monthly repayment
Home equity loans are repaid in fixed monthly payments, which means you’re guaranteed to pay equal amounts throughout the life of the loan. This is a good option if you’re prone to overspending, as it allows you to set a specific monthly fee to budget towards. However, it’s important to remember that if you cannot make these payments, you risk losing your home.
Fixed interest rate
A home equity loan offers a fixed interest rate throughout the term of the repayment. This is ideal if the environment currently offers low-interest rates. However, if you have bad credit or market rates suddenly drop significantly, you may have to refinance to secure a better rate.
Better credit option
Home equity loans offer lower interest rates than other forms of credit, such as credit cards and personal loans, which may make them a more appealing option to secure cash.
Pros of a HELOC
A HELOC is a revolving line of credit that enables you to borrow up to a preset limit, make minimum payments, and take money out again as needed. A HELOC remains open until the additional draw period ends and, because the borrowed amount can change, minimum payments can also fluctuate based on credit line usage.
HELOCs work in a similar way to credit cards in that both are open-end credit lines. However, while credit cards are unsecured, a HELOC is secured against your house. Therefore, failure to make HELOC payments could result in losing your home.
The benefits of selecting a HELOC include:
Adjustable interest rate
HELOCs often have a variable interest rate, which means the rate can go up or down over the years and the minimum payment will adjust accordingly. Therefore, your interest rate and payments could decrease as market interest rates go down and your credit rating improves.
This makes a HELOC a more complicated choice if you’re on a fixed income and might struggle to manage significant shifts in your monthly budget. Some lenders offer a fixed rate on HELOC, but this largely depends on your credit score and how much money you need to borrow.
A traditional HELOC gives you the option to spend as much or as little of the approved credit line as you like, within the confines of the maximum amount. This is a riskier option if you struggle to control your spending as it can be easy to impulse-spend your entire credit limit. But it can be helpful if you don’t require a specific amount of cash or have flexible spending options.
Draw and repayment
The draw and repayment process of a HELOC is an important consideration. A HELOC typically begins with a draw period, which enables you to withdraw funds for a specific amount of time and make interest-only payments, which tend to be relatively small. That’s followed by the repayment period, which tends to be longer, but the repayments become substantially higher as you’re now paying back the principal amount borrowed as well as the interest. Crucially, you can’t borrow more money after the draw period ends and the switch from interest-only to full payments can be a significant shock.
How does HELOC and HELOAN differ?
Taking out a home equity loan or HELOC can be a great way to find extra funds using your home as collateral. A home equity loan is typically the best option for a one-time expense with a fixed cost, such as home improvement or debt consolidation. In comparison, a HELOC is better suited to pay for expenses that may be charged over a longer period or unexpected costs, such as home repairs, education, and medical expenses. Home equity loans and HELOCs have closing costs and additional fees that can come to between 2-4% of the loan amount. Additionally, the interest you pay on both may be tax–deductible provided you use the funds to improve the home you’re using as collateral.
How does Figure stand out?
Figure’s HELOC rates are fixed, so if interest rates change, the new rate will only apply to new draws. Figure HELOC amounts range from $20,000 up to $400,000, with terms from 5 to 30 years. You could be eligible to borrow up to a CLTV of 80% if you have strong credit. What’s more, Figure charges a one-time origination fee only, so there are no account opening fees, maintenance fees, or prepayment penalties. Figure’s HELOC application process is 100% online — so you can get approved in five minutes with no in-person appraisal needed and secure your home equity line in as little as five days.1
If you’re ready to turn your home equity into cash, apply for a HELOC with Figure today!
1 Approval may be granted in five minutes but is ultimately subject to verification of income and employment. Five business day funding timeline assumes closing the loan with our remote online notary. Funding timelines may be longer for loans secured by properties located in counties that do not permit recording of e-signatures or that otherwise require an in-person closing. In addition, funding timelines may be longer if we cannot readily verify that your property is in at least average condition with no adverse external factors with a property condition report and need to order a desktop appraisal to confirm the value of your property.