Home equity loans and home equity lines of credit (HELOC) are two types of loans borrowers can use to access some of the equity in their homes.

Both loans use the borrower’s home as collateral, and as a result, can be a great way to access cash at lower interest rates and closing costs.

Borrowers can use the funds from these loans however they’d like, including debt consolidation or home improvements.

Read on to learn the differences between a home equity loan and a line of credit, the pros and cons and how to determine which type is right for you.

What is a home equity loan compared with a line of credit?

Home equity loans and HELOCs are second mortgages because they’re borrowed against a property that already has a home loan on it.

A homeowner must have a certain amount of equity in their home to obtain a home equity loan or line of credit. Mortgage lenders generally require at least 15% to 20% equity.

Calculate your home equity by subtracting your mortgage balance from your home’s current market value. With a home equity loan or line of credit, you can borrow up to 85% of your home’s value minus your remaining mortgage balance.

You’ll have to qualify for a home equity loan or line of credit, as is the case with any other home loan. Depending on lender requirements, you can expect them to require a good credit score, low debt-to-income ratio (DTI) and sufficient income.

Let’s take a look at a home equity loan alongside a line of credit and break down the differences between each.

Home equity loan

Home equity loans generally have fixed rates and a set repayment schedule.

You will apply for the amount you want to borrow based on your equity, and once approved, you will receive the funds as a lump sum. You can use these funds however you choose.

Common uses for a home equity loan include home repairs or renovations, consolidating high-interest debt such as credit cards or even putting a down payment on a second home.

Pros of a home equity loan

• Fixed interest and payments make home equity loans more predictable
• Lower interest rates than credit cards or personal loans
• Receive a large lump sum that you can use however you choose

Cons of a home equity loan

• It’s best to know the exact amount you need, or you risk running out of money or paying interest on funds you don’t need
• There’s a risk of losing your home if you can’t make your payments
• Must meet certain lender requirements, including equity percentages and good credit score

Home equity loans are a safe, predictable option for borrowers who know the amount of funds they need and who appreciate a fixed monthly payment.

HELOC

A HELOC operates much like a credit card. The borrower has a credit limit and a set borrowing period for withdrawing funds, repaying them and continuing to use them as needed.

Unlike a home equity loan, you won’t have a specified repayment amount each month. You will repay only what you used, and at a variable interest rate. (You will, however, need to make a monthly minimum payment.)

Interest rates are tied to a benchmark rate, which can adjust up or down throughout the life of the loan.

When the borrowing period ends, borrowers must repay the remaining balance. 

HELOCs are considered a more flexible equity loan option because borrowers can take what they need and only pay interest on what they use.

Pros of a HELOC

• Take out only as much as you need
• Lower interest rates than credit cards or personal loans
• Variable interest rates mean your rates could go down with better credit or market fluctuations

Cons of a HELOC

• Can be more difficult to budget if your payments fluctuate
• Variable interest rates could cause your rate to increase over time
• There’s a risk of losing your home if you can’t make your payments

How do I know which loan is right for me?

Both home equity loans and HELOCs allow borrowers to access a certain amount of equity to use for whatever purposes they choose, as long as they meet the lender requirements.

The right loan option for you depends on your specific goals and financial situation.

If you need a more flexible loan that allows you to take as you need and only pay interest on what you owe, a HELOC may be a better option for you.

If you know exactly how much money you need for a specific project or purpose, a home equity loan can offer predictable payments. 

You’ll know exactly how long it will take you to pay off the loan, and how much you will pay in interest over the life of the loan.

Apply for a home equity loan or line of credit with Compass Mortgage

A home equity loan or line of credit can help you tap into the precious equity locked up in your home, and you can use it for a wide range of projects and purposes.

To find out if you qualify for a home equity loan or HELOC, connect with the Compass Mortgage team today.

Compass Mortgage stands out from other lenders with our core values: to treat every person we meet with love and respect, to act with integrity, and to go above and beyond in all that we do.

We promise to be your partner and advocate throughout every step of the lending process.

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