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Part of the Series Home Equity Loans/HELOCTapping Your Home Equity
Home Equity Loan
Home Equity Line of Credit
Home equity loans and home equity lines of credit (HELOCs) are both secured by the borrower's home, and they usually have much more attractive interest rates than personal loans, credit cards, and other unsecured debt. But they can also be risky. The best home equity product for you will depend on your needs, goals, and spending habits. Let's take a look at how these two products differ.
A home equity loan is a fixed-term loan made by a bank or other lender to a borrower based on the equity in their home. Borrowers apply for a set amount and, if approved, receive it in a single lump sum. A home equity loan has a fixed interest rate and a fixed payment schedule for the entire loan term. It is sometimes called a home equity installment loan or an equity loan.
To qualify for one of these loans, you need to have enough equity built up in your home. Lenders use various formulas to determine that, such as your combined loan-to-value (CLTV) ratio. You can usually borrow up to 80% of your equity in the property.
As mentioned, a home equity loan's interest rate is fixed for the life of the loan, much like a fixed-rate first mortgage. The monthly payments are also fixed, split into equal amounts over the life of the loan. Portions of each payment go to the loan's interest and principal.
The repayment term generally ranges between five and 30 years. Whatever the period, home equity loans have stable, predictable monthly payments, making them relatively easy to budget for.
To calculate your home equity, estimate the current value of your property by looking at a recent appraisal or using the estimated value tool on a website like Zillow, Redfin, or Trulia. Be aware that these estimates may not be 100% accurate. Subtract the total amount you owe on your home from that figure to get your equity.
A home equity line of credit is a form of revolving credit that allows a borrower to take out money up to a preset credit limit, make payments, and then withdraw money again if they haven't reached their limit. Like home equity loans, they are secured by the equity in your home.
A HELOC's credit line remains open until its term ends, allowing you to use it as needed as long as you make your minimum required payments. Those payments will vary based on your outstanding balance at the time.
HELOCs typically have variable interest rates that can increase or decrease over the years, although fixed-rate HELOCs are sometimes available. The initial rate that a lender might offer you will depend on your creditworthiness and how much money you're asking for.
HELOC terms have two phases:
It's important to note that the transition from interest-only payments to full, principal-and-interest payments can be quite a shock, and borrowers need to budget for those increased monthly payments. It's also important to remember that while HELOCs work much like credit cards, because they are secured by your home you could face foreclosure if you're unable to keep up with the payments. Most credit cards, by contrast, are unsecured.
Both home equity loans and HELOCs allow you to borrow money for any purpose you have in mind. But depending on your situation, one may be more appropriate than the other.
Compared with a home equity line of credit, a home equity loan may be a better option if you:
For example, a home equity loan could be the right choice if you need money for a new roof or kitchen remodeling project, a wedding, or to pay off high-interest debts, such as credit cards.
Compared with home equity loans, HELOCs are a potentially better option if you:
For example, a HELOC might be the better choice if you are planning a series of home renovations or if you face years of college tuition bills. It could also be useful if you want to make sure you'll have some money available in an unexpected emergency.
Note that getting a good HELOC may be tougher today than it was a few years ago. In 2020, two major banks—Wells Fargo (WFC) and JPMorgan Chase (JPM)—put a freeze on new HELOCs and haven't resumed offering them as of this writing (July 2024).
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on characteristics like race, religion, sex, or age, file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
Under current law, the interest you pay on a home equity loan or HELOC is tax deductible only if the loan is secured by your main home or a second home and, as the Internal Revenue Service puts it, is "used to buy, build, or substantially improve the residence." However, that law is set to expire in 2025, after which the rules may change. Under the pre-2018 rules, the interest was tax deductible regardless of how you used the money.
If you need money as quickly as possible, a HELOC might be the better bet. Many lenders advertise home equity loan processing timelines of around 55 days, whereas some say their HELOCs can close in as little as two weeks, although they may take up to six.
If you need a large lump sum for a fixed expense you might consider a cash-out refinance (if you have sufficient equity in your home) or a loan from your 401(k) (if your employer allows it). If you want short-term access to a credit line with a low interest rate, a credit card with a 0% annual percentage rate (APR) for a certain introductory period could be an option, provided that you can pay it off before that rate expires. If you don't mind slightly higher interest rates and want to avoid the risk of foreclosure, a personal loan could be a worthy alternative. Each option has pros and cons that should be considered carefully.
For either a HELOC or a home equity loan borrowers will generally need:
It is possible to get approved without meeting these requirements by going through lenders that specialize in high-risk borrowers, but expect to pay much higher interest rates. If you are a high-risk borrower, it may be a good idea to seek out a credit counseling service for advice before signing up for a high-interest HELOC or home equity loan.
Home equity loans offer the stability and predictability of fixed rates and payments, while HELOCs provide ongoing access to money when you need it. As with any credit product, it's important not to get overextended and borrow more than you can pay back, especially when you're putting your home on the line.
Article SourcesTapping Your Home Equity
Home Equity Loan
Home Equity Line of Credit
A home equity agreement is a contract between a homeowner and an investor. The investor provides funds to the homeowner, who agrees to pay the money back and share any appreciation in the home's value.
Shared equity finance agreements occur when two parties purchase a primary residence because one party is unable to purchase the residence on its own.
A home equity loan is a consumer loan allowing homeowners to borrow against the equity in their home.
The home equity prepayment curve is a scale to measure the prepayment rate of home equity loans. It has a 10-month seasoning ramp before reaching a constant rate after that.
A contingency clause is a contract provision that requires a specific event or action to take place in order for the contract to be considered valid.
An FHA Single Family Title II is a type of mortgage issued by the FHA under Title II of the National Housing Act for a single family.
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