Home Equity Loan vs. Line of Credit



home equity loan vs HELOC

You can tap into your home’s equity to get a new loan or get a line of credit.

You can borrow up to 85% of your home’s value with a home equity loan.

In this article, we’ll explore the pros and cons of home equity loans and lines of credit to help you decide which is best for you.

What is a home equity loan?

A home equity loan uses the equity in your home for a new loan using your home as collateral for a new loan. They are also referred to as a second mortgage because the loan is secured by your home. With a home equity loan, you can borrow up to 85% of your home’s value.

2020 Home Equity Loan Requirements

• 680 minimum credit score

• No late payments in the last 12 months

• Loan-to-value ratio must be 70% or lower

• Maximum 45% debt-to-income ratio

• Borrow up to 80% of the home's market value

Home Equity Loan Pros and Cons

Home Equity Loan Pros and Cons

Pros

Cons

• Lower interest than personal loans and credit cards

• Reduces the amount of equity you have

• Interest on payments may be tax-deductible

• Closing costs between 2% - 5% of the loan amount

• Loan amount of up to 85% of the loan-to-value ratio ($425,000 limit)

• You can lose your home if you default on the payments

• Fixed interest rate and payments

• Higher interest rate than a HELOC

What is a home equity line of credit?

A home equity line of credit works like a credit card, which you can borrow from as needed instead of a lump sum. You will only be charged interest on the amount borrowed, and you can pay off the balance at any time.

HELOC Pros and Cons

Pros

Cons

  • Pay interest only on the amount borrowed

  • Reduces your equity each time you use it

  • Lower interest rates than home equity loans

  • Has a variable rate

  • Pay off and borrow at any time

  • Face foreclosure if unable to make payments

  • No fees to take out cash unlike a cash advance on a credit card

  • Closing costs between 2% - 5% of the line of credit

Home Equity Loan to Repair or Renovate Your Home

Home equity loans and HELOC should be taken out with caution. If you’re unable to repay the loan you risk foreclosure. It’s highly recommended to use a home equity loan to make home repairs or upgrades.

Reinvesting cash from an equity loan back into the home makes the most financial sense as it increases your home’s market value.

Using a Home Equity Loan for Debt Consolidation

Using your home’s equity to get a loan to repay a credit card or other types of unsecured debt is not a good idea. Credit card debt is unsecured, meaning if you don’t repay it, you won’t lose anything.

Paying off unsecured credit card debt using a home equity loan that is secured by your home is very risky. If you’re unable to make the payments you could lose your home. If you are struggling with credit card debt or other types of debts, a personal loan is usually a better option for debt consolidation.

Home Equity Loan Alternatives

Cash-out refinance – A cash-out refinance is similar to a home equity loan in that you’re able to convert your equity to cash. Instead of getting a second loan, you will get a new loan that covers your existing mortgage plus up to 80% of your home’s value.

Personal loan – A personal loan is an unsecured loan up to $100,000 with a fairly short loan term of three to five years. They have higher interest rates than home equity loans, but because they aren’t secured by your home you don’t risk foreclosure if you fail to make the payments.

Credit cards – A revolving line of credit will come with a high-interest rate and is best used for emergency expenses that arise. They are also unsecured.