HEL or HELOC: How to decide which is more affordable

At the time of price hike in US real estate sector, a huge number of people were looking for a way to utilize their home equity. They’re eagerly searching for affordable financing with a low interest rate.

If you're also looking for new source of funding, you might consider the home equity loan or a home equity line of credit option. But first, gather detailed information about both of these finance sources and mark the major differences.

1 Home equity loan (HEL)

Through a home equity loan you can get a fixed money backed up by your existing home equity. You’ll receive your loan amount at a time in one lump sum.

Your Loan to Value ratio will determine the amount you can qualify for. Apart from that, your homes’ condition, payment term, income and credit history will also be taken into consideration before approving the loan.

Home equity loan comes with a fixed rate of interest, fixed monthly payment, and fixed term. You may get 100% tax benefits on the interest paid toward your home equity loan.

2 Home equity line of credit (HELOC)

A home equity line of credit is considered as a revolving credit with the facility to use your home as a collateral.

Lenders approve a certain loan amount to the borrowers considering a percentage of their home's appraised value. The lenders also subtract the remaining balance on the existing mortgage.

While approving the loan the lenders may verify your credit history, current income, and other debts.

After getting approved for an HELOC, you’ll be able to utilize the money toward any kind of financial necessities. You may use a credit card or special checks to use that amount.

Few HELOC plans have certain criteria that require you to borrow a minimum amount, to keep a minimum outstanding amount or to withdraw an advance initially at the time of establishing the credit.

Most HELOC plans have a fixed time, called as the "draw period", that allow you to get your money from your allotted fund.

In the end of the initial draw period, you’ll have to renew the line of credit for getting your money continuously. However, not all lenders will give you that benefit. Some lenders take back the entire money within the first payment period.

So, borrowers must pay them back within the stipulated time to avoid penalty. However, few other lenders might also allow you to pay the money for an extended time period, called the "repayment period".

How is a home equity loan different from a home equity line of credit?

The main differences between a HEL and a HELOC are given below:

a The interest rates

The rate of interest you pay towards a home equity loan or HEL will be fixed.

Being the borrower you can determine the amount you need to pay and the amount will be fixed each month.

On the other hand, a home equity line of credit or HELOC has a variable rate of interest.

The rate of interest goes up or down based on a public index (that fluctuates according to the U.S. Treasury bill rate). Lenders might include a "margin" of a few percentage points.

b Repayment options

The method of repayment is another significant difference between HEL and HELOC.

You can pay a home equity loan with a fixed amount per month.

This payment will include both principal and interest payments. If you choose, some HEL plans have the option where you can pay a lump sum amount rather than the usual payment. However, in some other loans, you might have to bear a penalty for making advance payments.

Paying back an HELOC works the similar way, but the monthly interest rate may vary as per the index.

Many HELOC plans allow a borrower to pay only the interest amount. But that borrower must pay off the entire principal amount at the end of the draw period. This is called a “balloon payment”.

If any borrower fails to make this payment, he/she will need to refinance the entire amount with another lender.

Home Equity Loan or HELOC Loan - How can you decide ?

There are some factors you need to consider before determining which loan is best for you. These are:

When will you require the fund?
For how long do you need that fund - Long-term purpose or short-term purpose?
What are the interest rates?
How much monthly payment can you afford?
How long would be your first “draw period”?
Is your line of credit renewable when the life of the loan expires?
Are you getting repayment period?
How long will be the period of a closed end loan?
What is the lifespan of the line of credit?
Can you lease your home during the time of the loan?

When you consider HEL or HELOC, the main factor will be the reason for taking out the loan.

If you have a big single-time expense or want to settle your debts, a home equity loan is beneficial for you.
If you intend to meet current, relatively small expenses, an HELOC loan can be considerable to you. You’ll be charged interest only on the money you draw against your credit line. You can use the fund for different purposes as needed rather than borrowing the entire fund. An HELOC is also flexible for having emergency funds available without paying anything until you draw against your credit line.

HEL or HELOC : Cost comparison

Both these types of financing have higher interest rates compared to first mortgages. Most of the time variable or adjustable rates become lower than fixed rates. However, at the end of a “drawing period”, few HELOC plans allow the borrowers to shift their interest rates from adjustable to fixed rates.

A borrower also require to pay closing costs, escrow fees, fees for home appraisal and document recording for a HEL. A HELOCs don't require such costs and have lower upfront costs compared to a HEL.

So, you must consider all of these above-mentioned points before picking up the best option.

Try to compare the options with your current financial status so that you can afford the payments and increase your credit score by making on-time payments.

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