When you need extra cash ito cover large expenses, you can tap into your home’s equity. Accessing the equity in your home can be done in a couple of different ways, including a home equity line of credit (HELOC) or a home equity loan. Let’s compare a HELOC vs a home equity loan to help you determine which way is more suitable for you to access your home’s equity.
Key Points
- HELOCs and second mortgages both let you borrow from the equity in your home.
- A second mortgage is a lump sum loan, while a HELOC is a line of credit that lets you withdraw as much or as little money as you want as the need arises, like a credit card.
- Repayments on a second mortgage are typically fixed and predictable, while HELOC repayments are typically based on a variable rate.
- There is a risk to both financing options since your home is used as collateral.
What Is Home Equity?
Your equity represents the value of your home minus what you still owe on your mortgage, as well as any other liens that may be present on your property. Your equity is basically what you own outright.
HELOC Vs Home Equity Loan: Snapshot
| Second Mortgage | HELOC | |
| Fund distribution | One lump sum | Withdraw on an as-needed basis |
| Equity available | Up to 80% of the home’s value | Up to 65% of the home’s value |
| Interest rate | Fixed | Variable |
| Repayments | Regular installment payments over a fixed term | -Repayment phase takes place about 10 years after the draw period -Outstanding balance and interest is repaid -No more access to funds from the HELOC |
What Is A HELOC?
A home equity line of credit (HELOC) is a type of revolving loan. These financial products work similarly to credit cards, allowing you to borrow funds from a credit line multiple times, but setting a limit on the total amount that you can borrow.
With a HELOC, you have a set credit limit that you are allowed to borrow against whenever you need extra cash. As long as you have that credit available, you can borrow against it as needed, just like a credit card.
You don’t have to use the total limit available. You can borrow as often as you like. The credit will always be there when you need it.
What Interest Rate Do HELOCs Have?
The interest rates associated with HELOCs are usually low. That’s because your home equity collateralizes the loan, which lowers the lender’s risk. You’re only charged interest on the amount withdrawn rather than the entire credit limit. Once you repay the amount withdrawn and no longer owe anything on the credit line, and no interest will accrue.
How Much Can I Borrow With A HELOC?
The amount you can borrow with a HELOC depends on the amount of home equity you have. Generally speaking, you can borrow up to 65% of your home’s value. Or, if your HELOC is combined with your outstanding mortgage balance, you may access up to 80% of your home’s value.
To determine how much you can borrow, multiply the value of your home by 65%, then subtract the remaining mortgage balance from the total. For instance, if your home is valued at $600,000 and you have $200,000 remaining on your mortgage, the calculation would be as follows:
- $600,000 x 0.65 = $390,000
- $390,000 – $200,000 = $190,000
In this example, you can borrow up to $190,000 of your home’s equity with a HELOC.
How HELOC Draw And Repayment Periods Work
HELOCs often have two phases: a draw period and a repayment period.
Phase One – The Draw Phase
The draw phase is a period in which you can access your home equity credit at any time. During that time, you must make at least the minimum payments, which is the interest portion of the balance.
After about 10 years, the draw period concludes. In some instances, you may be able to extend it, but it all depends on your specific situation.
Phase Two – The Repayment Phase
The repayment phase is the time for you to repay your outstanding balance and residual interest. During this time, you are not permitted to access any more money from your HELOC.
HELOC Pros And Cons
Before you plan on taking out a HELOC, you should consider its pros and cons:
Pros
- Typically easier to get approved for — Since your HELOC uses your equity, it may be easier to qualify for. Your home backs the loan, which reduces the lender’s risk.
- Only pay interest on the amount withdrawn — Unlike a traditional loan which requires interest to be paid on the full loan amount, a HELOC only requires interest to be paid on the funds withdrawn, and not your entire credit limit.
- Access funds whenever you need them — Your HELOC works somewhat like a credit card, which lets you access the funds whenever you need it.
- Great flexibility — There are no regular payments to make. Instead, you can tap into your credit line as much or as little as you want without having to worry about repaying what you owe until your repayment period. That said, minimum payments may still be required, which are interest-only.
- No need to repeatedly apply for a new loan — Once you are approved for a HELOC, the account is available whenever you need it. You won’t have to re-apply for a new loan every time you need extra cash.
- Lower interest rate compared to other loans — Since your home collateralizes the loan, your lender may extend a lower interest rate, which makes this type of financing less expensive than other loan types such as a personal loan.
Cons
- Your home is at risk — If you default on your payments when they’re due, you risk having your home repossessed by the lender.
- More difficult to budget for payments — Since there are no regular installments made over a set term, it’s up to you to budget accordingly to ensure the loan is repaid when it comes due.
- Interest rates could increase — HELOCs typically only come with variable rates. That means the interest rate could increase at any point, which will subsequently increase the amount you owe on what you borrow.
- Self-discipline is required — Having easy access to a credit line can be very tempting, especially if you have poor spending habits. In this case, you could be vulnerable to overspending on credit.
- Credit limit could be reduced by your lender at their discretion — If your lender decides to lower your credit limit, you’ll have less money available to you.
What Is A Home Equity Loan?
A home equity loan is a financial product that lets you access the equity in your home. It’s also referred to as a second mortgage. Like a typical installment loan, a home equity loan provides funds requested in one lump sum. You must pay back this money in fixed installments, plus interest.
The loan also features a fixed payment schedule which details your payment dues dates. Term lengths range depending on the lender, who will determine how long you have to pay the borrowed equity back.
Like a typical mortgage, your home collateralizes a home equity loan. That means if you default on your home equity loan payments, your home will be at risk.
How Much Can I Borrow With A Home Equity Loan?
The amount that you can borrow against your home with a home equity loan will depend on how much equity you actually have, as well as what the lender is willing to offer you.
Generally speaking, homeowners must have at least 20% equity in their home before they’re able to take out this type of loan, which means you may be able to borrow as much as 80% of your home’s value. Some lenders might let you borrow more, but the interest rate would likely increase.
For instance, let’s say your home is worth $650,000, and the maximum amount you can borrow on from your home’s equity is 80%. In this case, you could borrow up to $520,000.
If you have a remaining mortgage balance of $200,000 on your mortgage, you’ll need to subtract this amount from the $520,000. This will leave you with $320,000 ($520,000 – $200,000). So, the most you can borrow in this scenario is $320,000.
Home Equity Loan Pros And Cons
Home equity loans have several perks and drawbacks, which you should consider before applying:
Pros
- Fund large expenses — You may be able to get approved for a higher loan amount with a home equity loan compared to an unsecured loan product. This can come in handy if you’ve got a particularly costly expense to cover.
- Predictable fixed monthly payments — If you prefer the stability and predictability of regular loan payments, then a home equity loan may be suitable for you.
- Fixed interest rate — Unlike HELOCs that typically come with a variable rate, home equity loan rates are generally fixed. That means your payments won’t change throughout the loan term.
- Can be used to consolidate debt — You can use the funds from your home equity loan for debt consolidation purposes. This can lower your interest costs and streamline your finances.
Cons
- Your home is at risk if you default — Your home secures your home equity loan. If you miss payments, you’ll be putting your home at risk for repossession.
- Higher rates compared to HELOCs — Interest rates are typically higher with home equity loans compared to HELOCs, though they’re often lower compared to other loan types.
- Costs and fees — There are fees and closing costs associated with taking out a home equity loan, similar to a mortgage.
Home Equity Loans Vs HELOCs: Which Is Best For You?
The loan type you choose will depend on your particular situation.
A HELOC may be best if:
- You want the flexibility to access to extra funds from time to time and don’t want to have to apply for a new loan every time.
- You like the idea of having a financial cushion to fall back on in the event of an emergency financial situation.
A home equity loan may be best if:
- You need a one-time loan to cover a large expense, such as paying for a home renovation.
- You like the idea of predictability and stability in loan payments.
- You prefer fixed interest rates to keep your payments unchanged throughout the term.
Alternatives to HELOCs and Home Equity Loans
There are other ways to tap into your home’s equity beside a HELOC and home equity loan:
Cash-Out Refinance
A cash-out refinance is a refinancing option that lets you convert home equity into cash. Like a regular refinance, you would replace your existing mortgage with a new loan.
But with a cash-out refinance, specifically, the new loan is bigger than the previous one, and you’ll receive the difference between the two in cash. In other words, you would refinance your mortgage for more than what you still owe with a cash-out refinance, then take the remainder in cash.
To qualify for a cash-out refinance, must have at least 20% equity in your home.
Reverse Mortgage
A reverse mortgage lets you borrow up to 55% of your home equity without having to sell your home. If you have enough equity, you can convert a portion of it into tax-free cash.
You won’t have to make any repayments while you’re still living in your home. The mortgage will only come due if you sell your home, move out, or pass away.
To qualify for a reverse mortgage, you must be at least 55 years old.
Looking For The Right Home Equity Product For Your Needs?
Deciding between a HELOC and a home equity loan comes down to your specific situation. Whatever decision you come to, Alpine Credits can help you through the entire process. Alpine Credits doesn’t see credit scores, income, or age as an obstacle to approval. Find your home equity value with Alpine Credit today and get approved for the loan you need.
HELOC Vs Home Equity Loan FAQs
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
