HELOC vs Home Equity Loan? This article will help you decide which is right for your next remodeling project.
When it comes time to renovate your home, do you have the cash to make it happen? Repairs, remodels, and upgrades can cost thousands, even tens of thousand of dollars, and most homeowners simply don’t have the available cash to fund this massive expense.
Fortunately, if you have equity in your home you can use a home equity line of credit, known as a “HELOC,” or a home equity loan to make it happen. These two options, while similar, have important differences. Making the right choice starts with having the best information on each option.
HELOC vs Home Equity Loan: How are They Similar?
Let’s start with what these two options have in common. These are two home-renovation loans that are secured with your home’s equity. Basically, you have to have a strong share of ownership in the home for these loans to be available.
“Equity” is simply how much the house is worth compared to how much you owe. In a simplified example, if the house is worth $500,000 and you still owe $250,000 on the mortgage, you have exactly 50% equity.
To use these loans, you will need some equity. Usually about 20% is enough, but there are options for as low as 10% equity.
Both of these loans allow you to convert equity into cash that can be used for a variety of purposes. Most don’t have limits on what you can do (some will), so you can use the funding for remodeling a kitchen, repairing the foundation, purchasing a new air conditioner, or building a deck.
HELOC vs Home Equity Loan: What are the Main Differences?
The main difference between these two options is how the money is accessed. One is a line of credit from which you can withdraw, while the other is a typical lump-sum loan.
HELOC (Home Equity Lines of Credit)
A HELOC uses your home equity to fund payments, but instead of giving you a specific amount, you are instead approved for a line of credit up to a certain point. Using this line of credit, you can make withdrawals as needed.
If you need to fund a variety of different projects, but aren’t sure how much you’ll need, you could get a HELOC for, say $200,000. You won’t be given a check for $200,000, but will instead have access to these funds, and you only repay what you withdraw. If it turns out you only need $100,000, then you’ll only make payments and pay interest on that $100,000.
Why Not Just Use a Credit Card?
If a HELOC is little more than a line of credit, why not just use a credit card instead of going to through process of HELOC approval? Because with a HELOC, your home secures whatever amount you borrow. Basically, if you are unable to repay, the bank has a lien on your property and could, potentially, seize the home to recover their funds. This has an obvious risk to the borrower, but it also reduces risk to the lender, allowing them to offer a more affordable rate and generous terms.
Home Equity Loans
Home equity loans, on the other hand, are more simplified and straightforward. Using your home’s equity, you apply for a loan for a specific amount and, assuming you are approved, receive a single check or direct payment.
Eventually, you repay the loan in fixed monthly payments. It’s an additional loan payment, which is why they are often called “second mortgages.”
HELOC vs Home Equity Loan: How to Make the Right Choice
Choosing the right one can be tough, but there is usually a better option based on your specific situation.
Choose a HELOC When…
…You are Not Sure How Much You Need
If you don’t know, for whatever reason, how much money you will need for the project, you may prefer a HELOC. Because this is a line of credit and not a lump-sum loan, you can withdraw as needed. With a home loan, you may borrow $100,000 and only need $75,000, which means you would be borrowing, and paying interest on, $25,000 more than required. With a HELOC, you can get approved for $100,000 but only withdraw what you need.
….You Have Numerous Small Projects
On the same note, if you have a wide variety of small projects, such as replacing a window, installing a new sink, replacing the washing machine, redoing the floors in one room, and fixing the door in another, as well as multiple other projects, then a HELOC could be the best option. With so many projects, it’s hard to estimate the costs, so a HELOC could be your best choice.
Choose a Home Equity Loan When…
….You Have One (or Two) Large Projects
While HELOCs are good for a home that needs multiple small projects, a home equity loan is often best for a large, single project, one that has a clear estimate for the costs. If you are remodeling the bathroom or kitchen, and you can get a direct estimate on the expenses, a home equity loan may be best.
….You Value a Lower Interest Rate
While HELOCs generally don’t have massive interest (thanks to securing the line of credit with home equity), a home equity loan tends to have lower interest rates. HELOCs may have adjustable rates, and the interest could be higher, so if you value a low fixed rate, you’ll probably want a traditional loan.
Use Your Equity to Improve Your Home!
If you want to learn more about the best home-renovation loans, contact our team today. We are proud to serve San Diego and the surrounding area, and we would love to help you upgrade and improve your home!
Whether you need a purchase loan, an investment loan, or a renovation loan, we are ready to increase your chances of mortgage approval!