HELOC VS HELOAN

What Is The Difference Between A Home Equity Line Of Credit (HELOC) & A Home Equity Loan (HELOAN)

HELOC vs HELOAN…If you are looking to borrow a little money based on the equity in your home, you might have come across the two main options: home equity line of credit (or HELOC) and home equity loan (HELoan). The question is what are the main differences between the two? And which one would be best for your situation? 

A Home Equity Line of Credit is a form of revolving credit. That means that it is an open account from which you can pull money when you need it and pay it down when you can. A Home Equity Loan is a set amount, with a set term. You get a lump sum and you pay that sum over time.

Let’s compare the details of the two types of credit.

Both the HELOC and the HELoan are secured by the equity in your home. So, in a sense, both of these are like second mortgages. The difference is in the flexibility of the two options. The HELOC will allow you to draw the funds when you need it. But the HELoan gives you the full amount you were approved for upfront. Let’s say you needed $100,000 for a home improvement project. With a HELOC, you would have an open account for $100,000. When you need to make a payment to a contractor, you could pull the exact amount of money you need from the account. With the HELoan, the bank would give you all $100,000 up front. The chief downside to the HELoan is that you immediately pay interest on the full $100,000 even though you might not need it immediately. 

This means that the HELOC payment is variable, because it will depend on how much you are currently borrowing. The HELoan is amortized, which means that the payment will be the same for the length of a fixed term. Your HELoan has a consistent payment for every month during the entire length of the term. The HELOC is open-ended. You could draw down and pay off the loan repeatedly over time. 

The interest rate you pay for a HELOC and a HELoan is different. A HELOC has a floating interest rate. It will change depending on the prime rate set by the FED. So, it is very possible that your interest rate could rise over time, even for the money that you have borrowed in the past. Similarly, it could drop over time. The rate usually only changes once a quarter, but how frequently it can change will depend on your loan terms. In contrast, the interest rate for HELoans is fixed. The interest rate you are given when you take out the loan is locked in for the life of the loan. 

For many HELOCs you are only required to make the interest payment each month. So, you could choose not to pay down any of the principal. That’s great if you run into a particularly tight month, but it also means you won’t be making any progress paying down the debt. Of course, for HELoans, that isn’t an option. Your payment will always include a principal paydown amount. 

When you draw money from a HELOC, there is sometimes a cash advance fee that is a percentage of the amount you pull out. Not all HELOCs have them, but you will need to be aware if the one you are considering does. A cash advance fee could make frequent push and pull of the money more expensive than you thought it would be. HELoans might charge an upfront origination fee. This is a percentage of the loan amount and comes out of the proceeds of the loan. Not all HELoans charge an origination fee, but you need to be aware that it isn’t uncommon. 

I do need to point out that if a fee is unavoidable, it will be included in your APR. That means when you are comparing options, the APR will represent the interest rate as well as fees. However, for HELOCs that might be more difficult to do upfront. If you have a cash advance fee and you repay the loan one month later, the APR is significantly higher than if you pay the balance off over the course of a year. 

Here is the summary of HELOC vs HELOAN

Let’s look at the Pros and Cons of HELOC vs HELoans.

The pros of a HELOC is that you only pay interest on the money you’ve pulled. You also have the ability to cover future emergencies because you have access to more money if you need it (and you haven’t maxed out your line of credit). Your interest rate could drop. And because a HELOC is secured against the equity in your home, it should have a lower interest rate and a higher line amount than you could get with an unsecured line of credit. 

The cons of a HELOC is that you have the temptation to overspend. And because the HELOC is secured by the equity in your home, defaulting on the loan could mean losing your home. Your interest rate could go up. If your HELOC has a cash advance fee, borrowing for short stints would be much more expensive than you expected. 

And finally, the HELOC payments are variable for three reasons: 1) the payment will obviously depend on the amount you are currently borrowing; 2) the payment will depend on the current interest rate that could change; and 3) the payment will change every month depending on how much you paid down the principal from the previous month. 

HELOC summary of Pros and Cons

Now let’s look at the Pros and Cons of HELoans. HELoans have predictable payment which can make it easier to plan out your monthly finances. They also have fixed interest rates so you don’t have to worry about your interest rate jumping up on you. And because the HELoan is secured with the equity in your home, you can usually get lower interest rates and higher loan amounts than you could with a traditional installment loan.

On the Cons side, you could lose your home if you default on the loan. Also, the structure of the loan means that you must borrow everything upfront that you are going to need. That means that you are paying interest for all of it from the beginning. And that interest won’t go down even if interest rates get better, unless you refinance the loan. 

HELoans summary of Pros and Cons

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