Choosing Which Home Equity Loan Option Is Right For You
Q: What are the differences between a home equity line of credit (HELOC) and a typical home equity loan?
A: Here are the differences between a HELOC and a typical Home Equity Loan.
How they work
A home equity line of credit is a revolving credit line that allows you to borrow money as needed to a limit, with your home serving as collateral for the loan. Lenders approve applicants for a specific amount of credit by taking a percentage of their home’s appraised value and subtracting the balance owed on the mortgage. They will also consider any outstanding debt you have, your income and your credit history.
If you’re approved for a HELOC, you can spend the funds however you choose. Some plans do have restrictions, though, and may require you to borrow a minimum amount each time, keep a specific amount outstanding or withdraw an initial advance when the line of credit is first established. Diamond Valley Federal Credit Union requires a minimum initial advance of $3,000.
HELOCs allow for more freedom than fixed home equity loans. Since you’re opening a line of credit and not borrowing a set amount, you can withdraw money as needed from the HELOC over the course of a set amount of time known as the “draw period.” This is especially beneficial if you’re renovating your home or using the money to start a new business and don’t know exactly how much money you’ll need to fund your venture.
Repayment options on HELOCs vary, but are usually very flexible. When the draw period ends, some lenders will allow you to renew the credit line and continue withdrawing money. Other lenders will require borrowers to pay back the entire loan amount at the end of the draw period. Others allow you to make payments over another time period known as the “repayment period.” We offer a 10 year draw period and if you have an outstanding balance at the end of the term, your loan will automatically convert to a repayment period. You are granted an additional ten years to repay the debt but no additional draws are allowed during this time. You can always apply to renew your line of credit if you still want to access your line.
Monthly payments also vary. We require a monthly payment of both principal and interest, while others only require an interest payment each month with the entire loan amount due at the end of the draw period. It’s beneficial to make principle and interest payments to avoid that lump sum coming due and payable at the end of the term. While Diamond Valley allows for a repayment period, some lenders do not.
HELOCs have variable interest rates. This means the interest you’re paying on the loan can fluctuate over the life of the loan, sometimes dramatically. This variable is based on a publicly available index, such as the U.S. Treasury Bill rate, and will rise or fall along with this index. Lenders will also add a few percentage points, called margin, of their own. Diamond Valley’s margin is dependent on your loan to value. For instance, if you are less than 79% loan to value, your margin would be a full percentage point under prime. On the other end of the spectrum, anything over 90% loan to value would have an additional two points added to prime.
HELOCs that only require repayment of principal at the end of the term can prove to be difficult for some borrowers. If you have trouble managing your monthly budget, you may not be able to pay back the full amount on time. In that case, you will be forced to refinance with another lender, possibly at an unfavorable interest rate. This is one of the reasons Diamond Valley offers a repayment period.
Home Equity Loans
How they work
A home equity loan, also secured by your home’s equity, allows you to borrow a fixed amount that you receive in one lump sum. The amount you will qualify for is calculated based on your home’s loan-to-value ratio, payment term, your income and your credit history. Most home equity loans have a fixed interest rate, a fixed term and a fixed monthly payment.
The primary benefit a fixed home equity loan has over a HELOC is its fixed interest rate. This means the borrower knows exactly how much their monthly payment will be for the entire life of the loan. Also, the interest paid on a home equity loan is often 100% tax deductible as long as it was used for home repair (consult your tax advisor for details).
Unlike the repayment policy of HELOCs, every payment on a home equity loan includes both principal and interest. Some loans allow borrowers to pay back larger sums if they choose, but many will charge a penalty for early payments. Regardless of policy, at the end of the loan term, the entire amount is paid up and you can forget about the loan. Diamond Valley Federal Credit Union does not charge a pre-payment penalty on our Fixed Home Equity product.
Taking out a fixed home equity loan means paying several fees. Receiving all the funds in one shot can also be problematic if you find that you need more than the amount you borrowed. Also, the set amount is due every month, regardless of your financial standing at the time. And, of course, if you default on the loan, you may lose your house.
Carefully weigh the pros and cons of each kind of loan before tapping into your home equity. Be sure to calculate whether you can really afford the monthly payments of your chosen loan.
Don’t forget to call, click, or stop by Diamond Valley to find out about the loans we have available for you.