Distinguishing a home equity loan from a home equity line of credit (HELOC) can be a puzzling topic, especially provided how similar their names are. Both options offer a variety of benefits and drawbacks, however, depending on your financial needs and situation, one option may prove to be more effective for you than the other.
To help you determine whether a home equity loan or a HELOC is right for you, let’s first discuss the differences.
Understanding A Home Equity Line of Credit (HELOC)
A home equity line of credit (commonly referred to as a HELOC) is a revolving loan — a flexible financial tool known for it’s repayment and re-borrowing flexibility. This means you can access credit again after you’ve paid it off.
A HELOC allows you to tap into equity that you have built up in your home. This equity is calculated by subtracting the overall value of your house from the outstanding amount on your mortgage. As a result, you’re left with a figure that represents capital that you are entitled to. This money can be accessed through different means of financing, such as a HELOC.
Similar to most mediums of revolving credit, HELOCs will not typically charge you interest until you actually use the money. Moreover, provided you are still within the disclosed draw period, credit will still be available to you after you’ve paid off the balance.
Repayment Periods For HELOCs
Typically, home equity lines of credit endure two key phases.
1) The Draw Phase:
During the draw phase, you’ll have access to available credit whenever you need it. Most often, HELOCs are very cost-effective for homeowners with cheap monthly payments. This is a result of the interest-only payments that you’ll be required to make.
2) The Repayment Period:
Each draw phase lasts for roughly 10 years after you receive the loan, at which funds will no longer be available to you. After this, homeowners enter the repayment period and will proceed to pay off any outstanding interest and outstanding balance.
This prolonged period of interest-only payments often causes financial difficulties for homeowners. Because of this extensive repayment period, many homeowners often find themselves behind on other bills and may eventually struggle to keep up with payments in a timely manner.
The Pros and Cons of HELOCs
As home equity lines of credit are typically revolving, their extended draw periods with interest-only repayments on the loan make them a very flexible option. When compared to classic mortgages, HELOCs may be much more accessible for homeowners. Not only can you end up with lower interest rates, but because you are basically just borrowing money from your own home, HELOCs may be preferred over mortgages.
However, HELOCs come with a handful of drawbacks as well. For instance, much more diligence is required, primarily when planning and responsibly enduring the “draw period.” Because this time frame may extend for up to 10 years, the concept of making interest-only payments may become deceiving over time, and many homeowners may find themselves overextending themselves financially. Furthermore, HELOCs from traditional banks still require you to pass a mortgage stress test in order to be approved. This may be especially difficult for homeowners with poor credit and unstable employment.
An Effective Financial Loan Solution
While HELOCs may provide their own set of advantages, most homeowners often opt for a home equity loan — a safe, valuable, and financially supportive second mortgage alternative.
Home equity loans still allow you to access your home equity, just like a HELOC, but not on a revolving basis. Instead, payment periods are made through part-interest, part-principle payments over the course of the loan term, after receiving your funds. Unlike loans from traditional banks, receiving a home equity loan from a specialized lender, such as Leap Financial, is significantly more efficient with easier approval processes.
For more information on why homeowners choose home equity loans over other mortgages and loans, be sure to check out this article. But if you’re ready to discover just how much you qualify for with a home equity loan, fill out our cost-free zero-obligation form, today!