A Guide to Understanding Home Equity Loans and HELOCs

By: iTHINK Financial | Jan 01, 2023

Homeowners seeking additional financing to renovate their homes, consolidate debt or prepare for emergencies may consider taking out a home equity loan or home equity line of credit (HELOC). Either option could be an essential solution for those struggling to cover expenses or looking to fund large purchases, and they are helpful for homeowners that are responsible with their finances and with repaying debts. But in order to determine if a home equity loan or HELOC is right for you, you must educate yourself on both options.

Determining whether to apply for a home equity loan or line of credit is simple when you have expert guidance to navigate the process. This article will go through a comprehensive guide for understanding both funding options to help you understand whether a home equity loan or HELOC is ideal for you.

What is a Home Equity Loan?

Home equity loans allow homeowners to borrow money while using their house as a type of collateral. Funds in a home equity loan are borrowed based on the total difference between your home’s value and its current mortgage or equity.

Some homeowners refer to home equity loans as a “second mortgage,” with loans being secured against your home’s equity value. Home equity loans are often a good option for homeowners due to their competitive rates and numerous benefits.

How Much Can I Borrow With a Home Equity Loan?

Home equity loans are disbursed in a lump sum of money and typically allow the borrower to borrow 80% to 85% of their home’s total value while deducting the amount the borrower owes on their current mortgage. Given the hefty amount you can borrow with these loans, home equity loans may not be right for you if you only need to borrow a small amount of money.

What Can I Use a Home Equity Loan For?

There are a number of ways to use a home equity loan that could benefit your home and family. While many homeowners apply for home equity loans to help finance home renovations, you are in no way limited to this option. Consider applying for a home equity loan to consolidate your high-interest personal debt, including credit card debt, auto loans, or other outstanding debt.

You can also use a home equity loan for emergency costs, such as medical bills, unemployment, business expenses, or education funds. These loans are famous for their versatility, and receiving your funds in a single lump sum can help you pay off expenses quickly.

What Are the Typical Interest Rates?

Home equity loan interest rates are typically higher than primary mortgages but less expensive than other types of credit. These loans are secured with your home’s equity and have fixed interest rates. Repayment terms for home equity loans are between 5 and 30 years, and the repayment period starts after your funds are dispersed.

Home equity loans have very reasonable interest rates compared to credit cards and other personal loans. With a home equity loan, you repay the same amount monthly, so you always know how to budget your monthly finances. Additionally, if you use a home equity loan to fund renovations, your equity loan could be tax-deductible. This interest deduction is another reason many homeowners prefer home equity loans to other funding sources.

What Are the Eligibility Requirements?

You will need a credit score matching your lender's minimum requirements to qualify for a home equity loan. Lenders will require you to provide proof that you can repay your loan on time and won't default on the payment. Additionally, your debt-to-income ratio for a home equity loan must be at most 43%.

What is a Home Equity Line of Credit (HELOC)?

Home equity lines of credit, referred to as HELOCs, are revolving credit lines that work similarly to a credit card. With HELOCs, you can borrow as much funding as you need as long as you don’t exceed a credit limit. Homeowners with a HELOC repay only the amount borrowed rather than the available amount.

HELOCs require homeowners to offer their homes as collateral, which is consistent with home equity loans. However, if you struggle to make your credit payments, you can fall into a rabbit hole of debt and might have to borrow additional funds to pay off your HELOC debt.

Because HELOCs are revolving funds, they are not provided in a lump sum like a home equity loan. However, a benefit of HELOCs is that they have lower closing costs than home equity loans or may not have any closing costs at all. Funds are easily accessible, and unused funds do not accrue additional interest.

How Much Can I Borrow With a HELOC?

Not all lenders adhere to a set amount of money when you use a HELOC. The sum of money you can borrow with home equity lines of credit is based on individual lenders and personal factors, including your total creditworthiness. Your creditworthiness is determined by factors such as your credit score, repayment history, and the debt you currently owe.

What Can I Use a HELOC For?

There are many ways to use your HELOC that you might consider if you choose to apply. HELOCs are often used for similar purposes as home equity loans, though some variations exist. Like home equity loans, HELOCs can be used to renovate your home, fund education, consolidate your debt, or prepare for any future emergencies.

Additionally, some homeowners use HELOCs for large purchases, which is uncommon with home equity loans. If you seek funding specifically for purchases like a once-in-a-lifetime vacation, a summer home, or a wedding, HELOCs are a wiser choice than home equity loans.

What Are the Typical Interest Rates?

A HELOC's interest rates vary depending on the lender and other personal factors for the borrower. With HELOCs, you pay interest only on the money they borrow rather than the total sum of what you can borrow. APR for a home equity line of credit is based solely on your interest and does not include points or financing charges.

What Are the Eligibility Requirements?

Eligibility requirements for HELOCs are similar to requirements for home equity loans. To qualify for most HELOCs, you must have a minimum of 15% equity in your home. Additionally, obtaining a HELOC is unlikely if you don’t have a healthy credit score. While some lenders approve HELOCs for borrowers with credit scores in the mid to high 600s, your score will ideally exceed 700 on the FICO scale.

To secure HELOC approval, you must show lenders your ability to repay the funds you borrow on time. Lenders want proof of your income, wages, and social security benefits, and these lines require a low amount of existing debt to qualify for approval. The max debt-to-income ratio (DTIs) for HELOCs is 43% to 50%, though many lenders require lower DTI ratios.

How to Get Home Equity Loans and HELOCs

Once you’ve decided between a home equity loan and a HELOC, you can begin navigating the application process, which is relatively straightforward when you follow the proper steps.

Regardless of which funding you apply for, looking into various lenders is essential to getting the most suitable loan for your needs. If you are still deciding which lenders to consider, start by reaching out to your current financial institution or credit union.

Get quotes from multiple lenders before deciding on one that suits your needs. While the option with the lowest rates might sound most appealing, it’s not always the best. There are additional factors to consider.

What Should I Look Out For?

As with any significant financial decision, there are precautions you must take when applying for a HELOC or home equity loan. Fraud is one concern you must look out for as you shop for lenders. Individuals can sometimes gather enough information from your HELOC documents to steal money, accounts, and identity information.

Additionally, both home equity loans and HELOCs pose a risk for homeowners in shaky financial situations because they require your home as collateral. If you are concerned that you can’t repay what you borrow, consider waiting to apply for home equity loans or HELOCs. If you are unable to repay, you could risk losing your home.

Get Expert Financial Services from iTHINK Financial

Expert financial guidance is essential if you are considering applying for an equity loan. Whether you’re drawn to a home equity loan or prefer to open a home equity line of credit, iTHINK Financial can help you navigate the process.

iTHINK Financial offers products, services and education for members looking to achieve financial well-being. Contact the financial experts at iTHINK Financial today to set an appointment and find an equity loan solution that’s right for you.