In this article, our experts have explained in detail the difference Between HELOC and the Home Equity Loan. So please read fully as it is complex but will provide a lot of knowledge.
When it comes to home buying, there are a few key things to keep in mind. One of those is the type of loan you should use – a home equity loan or a HELOC.
A lender gives a borrower fixed-term finance based on the equity in their home with a home equity finance.
Second mortgages are a kind of home equity loan. Borrowers apply for a specific amount of money and are approved for that money in a lump sum upfront.
A fixed interest rate and a set of fixed payments are included in a home equity loan for the duration of the loan. A home equity instalment loan or an equity loan are all terms for the same thing.
Why it’s called a second mortgage and operates similarly to a traditional fixed-rate mortgage is because the equity in your home serves as collateral. The initial mortgage must be paid down enough to qualify the homeowner for a home equity loan, but there must be enough equity in the property.
Home Equity Loan: A home equity loan is a loan that you take out against the value of your home to finance your purchase. This type of loan typically requires a higher down payment than a HELOC, and has interest rates that are typically higher than those on HELOCs.
However, most home equity loans have shorter terms (between 3 and 5 years) than HELOCs (which can last up to 10 years). Advantages of a home equity loan include the ability to use your home as collateral, and the fact that you can borrow up to 80% of the value of your home.
Disadvantages of a home equity loan include the fact that it may require you to sell your house if you want to get out from under it, and that it can be difficult – sometimes impossible – to get refinanced once terms have ended. In addition, homeowners looking for home equity loans are often unable to qualify based on their credit score.
Payments and interest rate on Home Equity Loan
A home equity loan will typically have fixed payments (e.g., every month) and a set interest rate over the life of the loan. The fixed payment and higher interest rate may be unfavourable as compared to a HELOC, especially if the introductory period of the loan is relatively short. For example, with a home equity loan, you will typically have 24 months of initial “grace” period before the payments.
This means that in year one, there is no principal but at least 18% of readjustment occurs over 6 years eventually resulting in 24%.
Thus actual principal does not start until 27 months after the loan is taken out. Therefore, for close to a third of its life (24+27), you will make interest payments on a floating charge that has no capital with which to build up equity.
With that said however the initial term may be 15 years as it is usual in case more than 40% MCLTV can apply depending upon the country where applicable regulations and all procedures must be implemented before borrowing by lenders.
Pros and Cons of Home Equity Loan
Pros of a home equity loan include the fact that you may be able to borrow up to 80% of the value of your home.
Cons of a home equity loan include the fact that it can be difficult – sometimes impossible – to get refinanced once terms have ended, and that payments and interest rate on Home Equity Loan Borrowing has been a back and forth process. Borrowers have had to contend with sometimes impossible refinancing terms, high-interest rates on these home equity loans, difficulty in ‘making’ the payments and sometimes short introductory periods (e.g., 8–12 months).
HELOC
A HELOC is a type of loan that allows you to borrow money against the value of your home, without having to sell it. This type of loan typically has lower interest rates than home equity loans, and you can use it either as a short-term solution (between 3 and 5 years) or as a long-term solution (up to 10 years).
Advantages of a HELOC include the fact that you don’t have to sell your house, and that you can borrow up to 80% of the value of your home.
Disadvantages of a HELOC include the fact that it’s usually easier to get a loan for 100% of the value of your home than it is for 85% or less, and that interest rates may increase over time.
Payments and interest rate on Home Equity Line of Credit
The APR is the annual percentage rate, which is calculated by adding together all of the interest rates on your loan. The applicable interest rate will be shown in black text on a Loan Estimate that you’ll receive from your lender.
The minimum required monthly payment will also be included in this document. This amount should always be paid even if you fall below 90% of your overall income due to hardship circumstances (such as a loss of a job or medical emergencies).
The 0% interest rate is the Annual Percentage Rate that will apply in Year 1, which can be found on your Loan Estimate Request. It’s important to keep in mind during the first year of a HELOC that you’re fully responsible for paying any negative balances shown as payment history for there may be no obligation to pay it down .
To protect yourself from falling into debt. If the loan balance exceeds 80% of the value of your home, then you may still have a requirement to pay monthly payments on any remaining amount and interest will accumulate. This results in a higher APR than usual.
It’s important to note that if you fall below 30 or 75% of your income share as calculated by Fannie Mae (FAIRcredit) for 3 consecutive months during Year 1, part or all current outstanding balance and interest may be subject to prepayment penalty premium.
For the purpose of this example, we’ll say you take out a $200 HELOC on your home with an APR of 10%. Your average monthly expenses are $2,000 per month.
In Year 1 you will have paying down or refinancing any negative balance showing as payment history (you can check it through Loan Estimate Request). You would pay ¼ of the remaining $100 in Year 1, paying an interest rate of 10% on that amount.
As for initial payments and mortgage insurance you’d still expect a similar payment schedule than what it would have been had you not taken out the HELOC (around ½ as much or more). After year 1, shown below is your Monthly Payment Schedule .
Pros and Cons of Home Equity Line of Credit
There are both pros and cons to taking out a home equity line of credit (HELOC). The biggest pro is that it can help you shore up your finances in an emergency or cover some short-term costs. The downside is that if you don’t pay down the principal balance quickly, the HELOC could become more expensive and risky to maintain.
It’s important to consider your long-term financial goals when considering whether or not to take out a HELOC. Some loans will provide unlimited deferment options before they need to be paid off (90 days is standard), so you won’t have to worry too much about having these debts serviced if you get yourself into a financial bind.
On the other hand, if you’re not sure when you’ll be able to pay off your loan, a HELOC may not be the best option for you. Paying interest on a HELOC can become costly over time, and it’s important to keep in mind that there is no specific grace period after which interest will stop accruing on these loans.
Conclusion: In this blog, we aim to provide an overview of what a home equity loan and HELOC are, their respective differences, and why you might want to choose one over the other. Hopefully, this will help you make an informed decision about which option is best for you. As always, if you have any questions or would like clarification, please feel free to reach your accountant or attorney.