I’m sure you’ve heard about different types of residential and commercial real estate loans but are you familiar with a heloc versus home equity loan? Both of these products use your home or investment property as collateral but they have different terms, requirements, and payouts.
Let’s decipher what is a heloc vs home equity loan, other names they go by, and key things to keep in mind before deciding if a home equity loan or real estate line of credit is right for you.
- HELOC: A home equity line of credit is also known as a real estate line of credit or an investment property line of credit. It’s a secured loan using the equity in your property as collateral. It has a draw period during which you can withdraw the funds. It’s similar to a credit card because you only pay back what you use.
- Home Equity Loan: A home equity loan, sometimes called a second mortgage, also uses the equity in your property but it isn’t as flexible as a HELOC. You’re given a lump sum and required to make monthly payments to repay the loan within its term.
- How to Invest in Commercial Real Estate with a HELOC or Home Equity Loan: Assuming the lending institution doesn’t have any loan restrictions, you can use your HELOC or home equity loan to invest in commercial real estate or renovate and market a property that you already own. You may also use the funds to partner up on a commercial real estate deal which makes the upfront costs less for each investor.
- HELOC vs Home Equity Loan Rates: HELOCs generally have lower interest rates than home equity loans. However, the exact interest rate will depend on the current market rates and the borrower’s qualifications including FICO score and debt-to-income ratio.
Pros and Cons of HELOCs
Pros of HELOCs include:
- Flexibility: HELOCs offer the flexibility of using money when you need it and only paying for the money you withdraw. For example, if you are approved for a $200,000 HELOC but only withdraw $50,000, you will only pay interest on the $50,000 you withdrew.
- Lower Interest Rates: HELOCs typically have much lower interest rates than other commercial loans, lower rates than second mortgages, and are cheaper than using your credit card
- No Fees for Withdrawals: Unlike a credit card company who charges cash advance fees, your lender may wave charge fees each time you want to withdraw funds during the draw period
Cons of HELOCs include:
- Variable Rates: Your interest rate may fluctuate and go up according to market rates. This can make the loan more costly.
- Impulse Spending: Some borrowers may be tempted to make multiple withdrawals and spend all the way up to the credit limit even if they don’t need all of the funds.
- Varying Minimum Payments: It may be difficult to budget for the minimum payments because they’re not all the same. Additionally, you may make minimum interest-only payments during the draw period and be stuck with larger payments later on.
Pros and Cons of Home Equity Loans
Pros of home equity loans include:
- Fixed Interest Rates: Your interest rates stay the same throughout the duration of the loan, so you always know what it will be, and don’t need to worry if rates rise.
- One Lump Sum: You borrow the funds and will receive them in one large lump sum. This may be helpful if you intend to use it all at once or if you don’t want to be bothered with multiple withdrawals.
- Fixed Monthly Payments: You can easily set up a monthly budget because you know how much your payment will be each month.
Cons of home equity loans include:
- No Flexibility: Your payments and interest rate are fixed and there is a specified loan term so you don’t have much flexibility regarding when and how you receive or payback the loan.
- House is Collateral: If you default on the loan, you risk losing your house or investment property that acts as collateral for the home equity loan.
- No Additional Funds: You only get the one lump sum and don’t have access to additional funds if an emergency pops up or you need more cash.
Key Differences Between HELOC vs Home Equity Loan
|HELOC||Home Equity Loan|
|Variable Interest Rate||x|
|Fixed Interest Rate||x|
|One Lump Sum||x|
|Ideal For Ongoing Expenses||x|
|Use Funds for Various Purposes||x||x|
How Do I Choose Between a Home Equity Loan and HELOC
When choosing a home equity loan vs a HELOC, you will need to think about a few things including when you need the funds, how much you need, and what you need the money for. For example do you want to look into types of real estate investment? Consider things like your budget, your spending style, and which option would better fit your needs.
A home equity loan could be better if you need a large amount of money for a specific event such as debt consolidation, paying for your child’s college education, or medical expenses. It’s also a better option if you want to pay the same amount each month and not worry about your payment or interest rate changing.
However, a HELOC could be better if you have an ongoing project such as home improvements or renovations where you will need money over time. It’s also better if an emergency arises and you already have access to the funds and can withdraw them as you need them.
How Do You Get a HELOC or Home Equity Loan
You can get a HELOC or home equity loan at your local bank or credit union or from an online lender. It’s always recommended to start with the financial institution that you have a relationship with first. You can get rates and terms on their loan products and compare them to what other lenders offer.
Requirements for getting a HELOC or home equity loan will typically include:
- FICO Score: The higher your score, the more likely you will be approved and the lower your interest rate will be. Minimum credit score requirements vary between lenders but a 621 or higher is usually required.
- Equity: The difference between what you owe on your mortgage and what your home is currently worth is what equity means. You need to have equity in your home to qualify for a HELOC or a home equity loan. The more equity the better.
- Debt-to-Income Ratio: This is your total debt divided by your gross annual income. Lenders will assess this and use it as a deciding factor.
- Income/Employment History: Lenders want to see that you can afford to pay back the loan, so they will look at two or more years of employment history and will want to see proof of your income.