A Home Equity Line of Credit (HELOC) can provide you with a substantial amount of funds that can be used for several purposes, including to cover the cost of renovations, debt consolidation or to cover the cost of higher education. Obtaining a HELOC can offer several benefits and, rather than having to borrow a set amount of money upfront, this line of credit can be drawn upon whenever you need it.
Home equity line of credit rates are always a variable rate, however, they are often lower than traditional unsecured loans as HELOC is a type of secured loan that uses your home equity as collateral. However, when learning more about HELOCs, it is worth taking the time to learn about alternative borrowing methods that may be available to you in order to make an informed decision before you apply for a loan.
How does a home equity line of credit work?
A Home Equity Line of Credit is a type of home loan that provides a revolving line of credit up to a percentage of a home’s equity. This line of credit loan can be drawn upon whenever you need for whatever you need, but a HELOC is most commonly used to fund:
- The costs of home improvement or renovation projects.
- The cost of higher education.
- Debt consolidation.
Unlike a traditional secured loan, you are not required to borrow immediately. In fact, some homeowners simply have a HELOC to use as an emergency fund, should a need ever arise.
A home equity line of credit is considered a “secured” line of credit, as you use your home’s equity as collateral for the loan. You may be eligible to obtain a HELOC if:
- You have at least 15 to 20 percent equity in your home (the difference between how much you owe on your home and the value of your home).
- You have a credit score of at least 620.
- Your debt-to-income ratio is below 50 percent.
Learn About the Benefits of an Equity Line of Credit
A home equity line of credit offers borrowers several benefits, including:
- Being easy to qualify for, as your home equity is used as collateral.
- Access to a line of credit rather than a set loan amount.
- Being provided with an access card or options to transfer funds online.
- Longer repayment periods, such as a 10 to 20 year repayment period.
- Ability to borrow multiple times from the same HELOC.
Potential Drawbacks of a Home Equity Line of Credit
While HELOCs offer several benefits, these lines of credit are not without their potential drawbacks, including:
- Home equity line of credit rates are adjustable and can increase during periods of inflation.
- Higher interest rate caps.
- You may have to pay closing costs with a HELOC and may include annual or early closure fees.
Home Equity Line of Credit vs Line of Credit vs Home Equity Loan
When determining whether or not to apply for a home equity line of credit, it is important to compare HELOCs to alternative loans that may suit your needs. Other common types of loans include lines of credit and home equity loans.
What is a home equity loan and how does it compare?
A home equity loan is a type of home loan that is similar to HELOC but includes a set borrow amount that is withdrawn immediately. In addition to immediate funds, you must make monthly mortgage payments on the loan. Payments will go towards your principal balance and interest.
While home equity line of credit rates are adjustable, loans have a rate that is generally fixed. Repayment lengths may also differ between loans and HELOCs depending on the amount that you choose to borrow.
When considering a HELOC vs home equity loan, it is also important to know that most HELOCs allow borrowers to draw funds more than once from the same line of credit while traditional home loans do not generally offer this feature. Additionally, you may accrue a fee from your lender if you pay your home loan off too early whereas HELOCs do not generally carry these penalties.
What is a line of credit loan and how does it compare?
A line of credit is similar to a home equity line of credit as borrowers have the option to choose what and when to borrow, up to the maximum allotted credit amount. However, lines of credit are less specific and are not always considered to be secure. A line of credit is “secure” if borrowers must put up some form of collateral, such as the equity on their home. Secure lines of credit typically offer competitive rates and can be qualified for more easily.
If you choose to apply for an unsecured line of credit, you will likely experience more stringent eligibility requirements, higher interest rates and you may not receive a large credit line. However, one key difference between an equity line of credit and a standard one is that most lines of credits cannot provide the amount of funds as a HELOC or home loan.
The Bottom Line for a HELOC, Line of Credit and Home Equality Loan
While a home equity line of credit, line of credit and home equity loan may all be able to provide you with the funds that you need, each of these types of loans offers different benefits and are associated with different potential drawbacks. Therefore, it is important to select the type of loan that will be best suited for your needs. For example, if you are interested in having access to an emergency fund (should you need one), a HELOC will probably be the best choice for you.
In addition to the reason you are seeking a loan or line of credit, it is important to consider interest rates, the fees that you may accrue and the amount of funds that you may need. Additionally, each type of loan will come with its own eligibility requirements, including minimum credit score and debt-to-income ratio requirements.