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Comparing a Home Equity Loan to a Home Equity Line of Credit (HELOC)

Comparing a Home Equity Loan to a Home Equity Line of Credit (HELOC)

    Home equity loans and lines of credit are similar in that both allow you to borrow money using the equity in your property without refinancing your existing first mortgage.  Borrowers can use both for numerous purposes including home remodeling, paying off credit card debt or buying a second home or investment property.  The biggest difference between a home equity loan and home equity line of credit (HELOC) is that with a home equity loan you receive the entire loan amount up-front when you obtain the loan as compared to a home equity line of credit that enables you to borrow money from, or draw down, the line of credit as needed.

    Additionally, the initial interest rate for a home equity line of credit is typically lower than for a home equity loan but it is subject to change over time. Plus with a home equity line of credit you typically only pay interest and no principal on the outstanding loan balance during the first several years, which results in a lower monthly payment, while a home equity loan requires borrowers to pay both principal and interest over the entirety of the loan.

    So how do you determine if a home equity loan or home equity line is better for you? The answer depends on your situation and financial objectives.  Below, we review when each option makes sense for borrowers and provide a table that compares their key attributes so you can select the financing alternative that is right for you.

  • When a Home Equity Line of Credit is Better than a Home Equity Loan
  • If you want to have the ability to borrow against the equity in your property but you do not have a definitive use of proceeds or immediate need for the money, then the home equity line is the right option because it allows you to draw down, or borrow from, the line only when you need the money.  The home equity line also allows you to draw down, pay off and then draw down the line of credit an unlimited number of times, providing greater financial flexibility than a home equity loan.  The home equity line also typically has a lower monthly payment than a home equity loan because the interest rate tends to be lower and you typically pay only interest and no principal during the first ten years of the home equity line.  Interest rates are subject to change, and possibly increase with a home equity line, which is a potential risk with a home equity line of credit.  Finally, if you know you are going to pay-off the loan within a set period of time such as within three-to-five years, before the end of the loan term, a home equity line of credit is likely the better option.  This is because you benefit from the lower interest rate and monthly payment at the beginning of the line of credit but you minimize the risk your interest rate and payment increase by paying off the line early. 

  • When a Home Equity Loan is Better than a Line of Credit
  • If you have a definitive use of proceeds for the loan and are concerned about interest rates increasing, then the home equity loan is the right option because it allows you to borrow money at a fixed interest rate.  Although you lose the financial flexibility associated with a home equity line, you receive all of the loan proceeds up front and also eliminate the risk that your mortgage payment increases if interest rates rise in the future.  Additionally, if you do not intend to pay off the loan balance early, then a home equity loan is likely the better option because it eliminates the interest rate risk for the entire loan term.  If you intend to pay off the loan early, shortening your loan term mitigates the interest rate risk and a line of credit may be the better option.  The downside to a home equity loan is that you borrow the entire loan amount up-front even if you do not have a use for all of the loan proceeds and you cannot use the loan to borrow more money if you pay back all or part of the outstanding balance (you would need to obtain another home equity loan which may be challenging if you have not completely paid off your original home equity loan). 

  • Comparing a Home Equity Loan to a Home Equity Line of Credit
  • The table below compares the key features of a home equity loan and home equity line of credit

Home Equity Loan Home Equity Line of Credit
Loan Proceeds Received Up-front As Needed
Ability to Borrow Money Over Time No Yes
Typical Interest Rate Type Fixed rate
  • Interest only (adjustable) for first 10 years
  • Fixed rate for last 15 or 20 years
Relative Interest Rate Higher Lower
Interest Rate Can Increase No Yes (during first 10 years)
Relative Monthly Payment Higher Lower
Monthly Payment Can Increase No Yes (during first 10 years)
Typical Term 15 years 25 or 30 years (ability to draw down line during first 10 years and the line converts into an amortizing loan for last 15 or 20 years)
Use of Proceeds Borrower determines Borrower determines
Maximum Combined Loan-to-Value (CLTV) Ratio ~80% - 90% ~80% - 90%
Maximum Debt-to-Income Ratio ~55% ~55%
Position / Seniority Second mortgage Second mortgage
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    Points  More Info:
    Points: Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
     
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    Monthly Housing Payments
    P & I More Info
    Principal & Interest: A periodic payment, usually paid monthly, that includes the interest charges for the period plus an amount applied to the reduction of the principal balance.
    Mortgage Insurance More Info
    Mortgage Insurance: The monthly cost for a policy that protects the lender in case you’re unable to repay the full amount of the loan. It is typically required for loans that have a loan-to-value ratio between 80% to 100%.
    (Estimated)
    Property Tax More Info
    Property Tax: (Also called "Real Estate Tax.") Property taxes are government assessments on real estate property. With mortgage financing, the local, county or state tax assessment on real estate property is considered part of the monthly housing obligation and typically collected and set aside by the lender ...
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    Homeowner Insurance More Info
    Homeowner Insurance: or also commonly called hazard insurance, is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one’s home, its contents, loss of its use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.lender ...
    (Estimated)
    Homeowner Association Fee More Info
    Homeowner Association fee: (HOA) fees are funds that are collected from homeowners in a condominium complex to obtain the income needed to pay (typically) for master insurance, exterior and interior (as appropriate) maintenance, landscaping, water, sewer, and garbage costs.
    (If Any)
    Total Monthly Housing Payments
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    Points More Info
    Points Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
    Origination Fee More Info
    Origination Charge: A loan origination charge is a fee charged by the lender for evaluating, processing, and closing the loan.
    Credit Report Fee More Info
    Credit Report Fee: Fee charged to obtain an applicant’s credit history prepared by one or all of the three major credit bureaus. Used by lender to determine the borrower’s creditworthiness.
    Tax Service Fee More Info
    Tax Service Fee: A fee charged by the lender to cover the cost of retaining a tax service agency. These agencies monitor the property tax payments on the property and report the results to the lender.
    Processing Fee More Info
    Processing Fee: A processing fee is a charge by the lender for clerical items associated with the loan. Examples of processing include loan set up, organization of loan conditions for underwriting, and preparing required disclosures for the borrower.
    Underwriting Fee More Info
    Underwriting Fee: A fee charged by the lender to verify information on the loan application, authenticate the property’s value, and perform a risk analysis on the overall loan package.
    Wire Transfer Fee More Info
    Wire Transfer Fee: In most cases lenders wire funds to escrow companies to fund a loan. Commercial banks that perform this function will charge the lender so the fee is generally passed on to the borrower.
    (If Any)
    FHA Upfront Premium More Info
    FHA Upfront Premium: A fee paid in cash at the close of escrow or more commonly it is financed into the loan. These premiums are pooled together by the FHA and are used to insure the risk of borrower default on FHA loans. FHA upfront premiums are prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of the loan, they are entitled to a partial refund of the FHA upfront premium paid at loan inception.
    (If any)
    VA funding Fee (If any)
    Flood Fee
    Other Fees More Info

    Other fees could be either additional Administrative Fees that a lender charges or it could be a Flat Fee to cover all lender charges such as: (Origination Fees, Points, Underwriting and Processing Fees, Credit Reports and Tax Service Fees)

    The flat fee does not include prepaid items and third party costs such as appraisal fees, recording fees, prepaid interest, property & transfer taxes, homeowners insurance, borrower’s attorney’s fees, private mortgage insurance premiums (if applicable), survey costs, title insurance and related services.

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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
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