Home Line of Credit vs Home Equity Loan: Key Points To Know

Home equity lines of credit and home equity loans use the borrower’s property as collateral and usually offer better interest rates than other loan types. You may want to perform a home renovation plan or other financial needs, and this is where home equity lines of credit and home equity loans come in. 

Ideal home equity will be dependent on your financial goals and spending patterns. RenoFi loans are ideal if you intend to renovate your home and can’t afford to fund the large projects on your list. Here are the similarities and differences you should know about home equity lines of credit and home equity loans:

What You Should Know About a Home Equity Loan

A home equity loan is essentially a second mortgage that enables you to utilize your home’s equity as collateral to get financing. This means that you use your property as security to protect the financier if you fail to pay for the loan. The financier disburses the funds to you in full at a fixed or variable interest rate and allows you to pay your monthly installments for a specific period. 

A home equity loan allows you to access as much as 80% to 85% of the total value of your property, subtracting the outstanding mortgage amount. A financier may use common criteria before lending you money, such as the combined loan-to-value ratio (CLTV). 

With a fixed rate, the monthly installments are divided into certain amounts that go to the interest and principal amount. The repayment period is usually set to five to 30 years, depending on the lending institution. You can easily plan for a home equity loan repayment with a fixed rate since they generally offer a steady and predictable installment.

Pros of Home Equity Loans

• Home equity loans are distributed in a lump sum, making it easy to plan for larger projects and expenditures.
• When you have fixed monthly installments, it’s easier to plan for repayment and other home expenses.
• Home equity loans generally offer minimum interest rates compared to other financing options available. 

Cons of Home Equity Loans

• A borrower can’t get more funds for emergencies without applying for another loan.
• To get the minimum rates, you may need to refinance
• The financier has the legal right to repossess the home if you default on the repayment to recover their losses.

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

A home equity line of credit is a secondary mortgage that enables you to access financing against your property’s equity as a line of credit. You can use a HELOC to finance expenses like home improvement projects, education, and consolidating credit card outstanding amounts. 

A home equity line of credit offers a draw period and a repayment period. The draw period opens you an opportunity to use the line of credit, and you only need to pay for the interest of what you borrowed. When the draw term ends, you start making payments depending on the principal and remaining interest amount. 

HELOC’s interest rates are usually variable, and they change depending on market changes. The loan rates that a financier will offer you are based on the credit rating and loan amount you are seeking. While HELOCs function as credit cards, they are secured by your property, which puts you at risk of foreclosure if you default on payment.

Pros of Home Equity Lines of Credit

• You have the freedom to choose the amount you want to spend on your credit line.
• The interest rates and payments may drop depending on the market situation.
• The interest rates are typically lower for HELOCs than unsecured loans.
• If the credit line is open for a certain period, you can use the amount for emergencies.

Cons of Home Equity Lines of Credit

• The changing interest rates may make it challenging to plan for your projects and expenses.
• The interest rates may rise depending on the market situation.
• You can spend as much as you want until you reach your credit limit.
• You risk losing your property if you default on payments, as the lender reserves the legal right to your home ownership until full payment is made.

Similarities of Home Equity Loans and Home Equity Lines of Credit

• These loans are secured, meaning you stand to lose your home if you fail to pay for the loan.
• Both HELOCs and home equity loans have closing charges, where you pay the financier a certain amount when you close on financing. These charges vary depending on the financier. In some cases, you will need to pay for appraisal, credit report, title search, and origination charges.

Differences Between Home Equity Loans and Home Equity Lines of Credit

• A home equity loan often has a fixed rate that doesn’t fluctuate during payment.
• A HELOC typically has variable interest rates that are based on current market conditions.
• Regularly scheduled installments repay a home equity loan.
• A HELOC operates on an open-ended basis, where the outstanding amount of a specific failed month carries over to the next month. This loan is called a revolving debt. Other revolving debt accounts include a personal line of credit, HELOC, and a credit card.

Requirements When Accessing a Home Equity Loan or HELOC

• The lender evaluates your home equity, credit rating, and debt-to-income ratio (DTI). A home equity loan requires that you have a credit score of 600 and above, and for a HELOC, you need a credit rating of 700 and above. The lenders also require that your home equity is at 20%. The debt-to-income ratio should be at 43% or below for both loans.
• You need a home appraisal for both loans to determine the market value of the property.
• You also need to pay for the closing charges to acquire both loans. The closing charges depend on your loan type and where you stay.

Benefits of RenoFi Loans

In some cases, a traditional 90% LTV HELOC may sound like a viable option to fund any home renovation projects you have scheduled, but it often doesn’t work because the available equity isn’t enough to tackle your entire wishlist. One way to solve that is to take into account the After Renovation Value of your home and use that to increase the available equity - this is what RenoFi loans do. 

Let’s say, for example, your home is currently valued at $500,000, and your outstanding mortgage balance is $400,000. You are planning a big renovation and expect that the after-renovation value of your home will be approximately $640,000. 

Your current loan-to-value ratio (LTV) is at 80%, which means that you effectively can’t borrow anything to fund your renovation. A RenoFi loan, however, would allow you to go as high as 150% LTV or 90% LTV using the after-renovation value.

So, in this example, while using a standard home equity loan results in your borrowing power being $0, a RenoFi loan allows you to borrow up to $176,000, thanks to the after-renovation value of your home!

If you are considering a home renovation, RenoFi is by far the smartest way to finance your project. 

Choosing Between a Home Equity Loan and a Home Equity Line of Credit

Home equity is ideal if you need a huge amount of cash for emergencies or home renovations. A HELOC may be more favorable if you require revolving funds that you can use as needed. RenoFi loans, on the other hand, are the smartest way to finance a large home renovation project. 

Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans focus on your home’s projected value post-renovation. This enables you to secure approximately 11X more in borrowing, enjoy a reduced monthly payment, and maintain a favorable interest rate on your initial mortgage.