Home Equity Loans vs Home Equity Lines Of Credit

Sometimes it may feel that your every spare minute is spent working around the house. Yardwork, cleaning, home improvement. It all adds up. In fact, it all adds up in a different way as well – home equity.

Here, we’ll focus on two of the three ways (the other being cash-out refinancing) to tap into the equity you’ve built up: home equity loans and home equity lines of credit. Just read on to learn more.  

What are the differences between a traditional home equity loan and a home equity line of credit (HELOC)? What are the advantages/disadvantages of each?

If you’re a homeowner, you can borrow against the value of your house through either a home equity loan (often called a loan) or a home equity line of credit (often called a HELOC or a line). A traditional home equity loan is a closed-end second mortgage with a fixed term, fixed interest rate and fixed monthly payment (although adjustable rate home equity loans are also available). With a home equity loan, all the money is disbursed in a lump sum up front at the time of closing. A HELOC is a credit line with as little as zero drawn up front, usually with an adjustable rate and payment. Essentially, a HELOC is like a credit card in that you can use what you need and can repay all or the minimum payment each month.

Depending on the borrower, which is the right loan to pursue?

Generally, a HELOC is a good choice to meet ongoing cash needs, such as college tuition payments or medical bills. Those who are self employed, paid by commission or rely on a year-end bonus will also enjoy the flexibility of the credit line provided by a HELOC. Basically, a HELOC is like a checking account or a credit card, and can be paid down and drawn out again repeatedly. Conversely, a home equity loan is more suitable when you need money for a specific, one-time purpose, such as buying a car or a major renovation. It is also more appropriate for someone on a fixed income that needs the consistency of a monthly payment.

Which is easier to qualify for/obtain? Have lending restrictions on either type of loan become stricter? Why?

The ability to qualify for both home equity loans and home equity lines of credit are essentially the same. In today’s market, guidelines are fairly tight with most lenders requiring a credit score higher than 680, and a combined loan-to-value ratio of the first and second mortgages in the 80-90% range. Homeowners with high credit scores – above 720 – will qualify for the best rates. When exploring your options, homeowners should also consider a cash-out refinance which will generally offer a lower overall interest rate on both loans and have easier qualification guidelines.

Under what conditions should you avoid a HELOC? Under what conditions should you avoid a traditional home equity loan?

If you’re on a fixed income budget and require a stable, consistent monthly payment, a home equity loan will be a better choice. HELOCs are better suited for folks who need flexibility in their monthly cash flow, or just want to have an emergency line of credit for unexpected expenses. In either case, a qualified loan consultant can help a homeowner understand the tradeoffs of each loan type, and the advantages and disadvantages of having two loans compared to a single larger loan.

Is now a good time to even consider one of these loans, considering the state of the lending market and real estate market? Is it better to perhaps wait until the subprime mess is further resolved or rates/terms improve for borrowers?

There is really no reason to wait. The present low long-term interest rates are very attractive rates in any market. The impact of the sub-prime credit crunch has been for lenders to tighten the guidelines and make these loans harder to qualify for. Again, a qualified loan consultant can quickly explain your options based on your individual situation.

How have home equity loans and HELOCs changed over the years? Have these products improved or become more complicated?

Banks have made HELOCs easier to get in recent years and have offered incentives such as no closing costs and introductory teaser rates for the most creditworthy homeowners. The ability to access your HELOC via credit card also greatly increases the flexibility of this loan.

Where is the best place to apply for a home equity loan or HELOC – a traditional bank/lender? A mortgage lender?

Banks, mortgage banks and other direct lenders will be the best choice. Some lenders have attempted to offer self-service HELOCs on their websites with limited consumer acceptance.

The Important Points To Remember

If you are thinking about a home equity loan or a HELOC, you should apply as soon as possible. The national trend toward declining home values means you will qualify for less money today than you might have a year ago. Speak to a qualified loan officer who can explain several different options, and make sure you never agree to a pre-payment penalty.