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A Home Equity Line of Credit (HELOC) and a Home Equity Loan are two financial products that allow homeowners to borrow money against the equity they have built up in their home, but they are not exactly the same. They have many similarities, but also key differences.
HELOC (Home Equity Line of Credit)
A HELOC is a revolving line of credit that allows you to borrow money against the equity in your home. It works somewhat like a credit card, where you can borrow up to a certain limit and pay interest only on the amount you borrow. You can draw funds from your HELOC as needed and repay them over time. HELOCs typically have variable interest rates.
Home Equity Loan
A home equity loan, frequently referred to as a second mortgage, provides a lump sum of money upfront that you repay in fixed monthly installments over a set period. The interest rates for home equity loans are usually fixed, meaning they remain constant throughout the loan term.
HELOC Pros:
HELOC Cons:
Home Equity Loan Pros:
Home Equity Loan Cons:
Both options have their advantages and disadvantages, and the best choice depends on your individual financial situation, the amount of money you need, and how you plan to use the funds.
Money expert Clark Howard has a hard and fast rule about when you should get home equity loans and HELOCs:
“Use home equity lines to improve your home. That’s the ONLY reason to get one.”
Do not use your home equity to pay off credit card debt. Credit card debt is unsecured, meaning it doesn’t put your assets at immediate risk if you fail to pay. In contrast, mortgage debt, including that from a second mortgage like a HELOC or home equity loan, is secured by your home. Failure to meet these payments can lead to losing your home.
Additionally, if there’s a significant drop in housing values, having a second mortgage could result in owing more on your home than it’s worth, a situation known as being “upside down” on your mortgage. This will be exacerbated if you have used the home equity debt for something other than home improvements.
If you use a HELOC, you should have a plan to repay it within 3 years. Anything longer than that exposes you to the risk of unexpected increases in interest rates.
Both a Home Equity Line of Credit (HELOC) and a Home Equity Loan can have an impact on your credit score, but they can affect it in slightly different ways due to their distinct structures:
Both HELOCs and Home Equity Loans can impact your credit score through inquiries, the amount of debt you carry, your payment history, and your credit mix. However, the HELOC’s impact on your credit utilization ratio is a unique aspect that differs from the effect of a Home Equity Loan.
If you decide to get a HELOC or Home Equity Loan, make sure you use our HELOC calculator or our Home Equity Loan calculator to estimate your monthly payments and your total cost of borrowing.
This post was last modified on April 4, 2024 2:31 pm
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