Is a home equity loan the same as a HELOC?
Home equity lines of credit (HELOCs) and home equity loans are similar methods of borrowing money against the ownership stake you have in your home. A HELOC is a line of credit with a variable interest rate, while a home equity loan is a lump sum paid back in fixed installments.
The line-of-credit arrangement also means you'll only pay interest on the amount you borrow, at least initially. With a home equity loan, you'll be responsible for interest on the entire loan balance, even if you don't use all the funds.
Lenders require an appraisal for home equity loans—no matter the type—to protect themselves from the risk of default. If a borrower can't make monthly payments over the long-term, the lender wants to know it can recoup the cost of the loan. An accurate appraisal protects borrowers too.
Loan payment example: on a $50,000 loan for 120 months at 8.40% interest rate, monthly payments would be $617.26. Payment example does not include amounts for taxes and insurance premiums.
Despite their advantages, home equity loans come with many risks — like losing your home if you miss payments. You could also wind up underwater on the loan, lower your credit, or see rates on the loan rise. Reading your loan documents carefully can help you prepare for and avoid many of these risks.
To qualify for a HELOC, you must have equity in your home and maintain a low debt-to-income (DTI) ratio. You will also need a good credit score and proof of income. The amount you can borrow with a HELOC depends on the value of your home and the amount of equity you have built up.
The most obvious downside to a HELOC is that you need to use your home as collateral to secure your loan. In today's rising interest environment, the fact that HELOCs have variable interest rates is also less advantageous, as the Federal Reserve has indicated that it will need to keep interest rates higher for longer.
Example 1: 10-year fixed-rate home equity loan at 9.09% interest. The average interest rate for a 10-year fixed-rate home equity loan is currently 9.09%. If you borrowed $100,000 with that rate and term, you'd pay a total of $52,596.04 in interest. Your monthly payment would be $1,271.63.
The variable interest rate could increase, and if you're unable to pay back the loan for whatever reason, you could lose your home. In addition, you might end up with a false sense of bottomless funds during the draw period, which can make for a stark return to reality when the payback period begins.
If you are ready to have your home appraised, you should address any significant issues that may affect your home's value—such as damaged flooring, outdated appliances, and broken windows. A messy home should not affect an appraisal, but signs of neglect may influence how much lenders are willing to let you borrow.
How quickly can you get a home equity loan?
How fast can you close on a HELOC? Getting a home equity line of credit typically takes two to six weeks from application to closing, but the exact time frame varies by lender.
Home equity loans are relatively easy to get as long as you meet some basic lending requirements. Those requirements usually include: 80% or lower loan-to-value (LTV) ratio: Your LTV compares your loan amount to the value of your home. For example, if you have a $160,000 loan on a $200,000 home, your LTV is 80%.
The current average rate for a 15-year fixed-rate home equity loan is just slightly higher than the 10-year average rate at 9.09%. If you took out a loan for $150,000 with these terms, you're monthly payment would come to $1,529.44.
Company | Forbes Advisor Rating | Days to close |
---|---|---|
PNC Bank | 5.0 | Average closing time is 45 days |
LoanDepot | 4.5 | 20 days |
Bank of America | 4.0 | 30 to 45 days |
Now let's calculate the monthly payments on a 15-year fixed-rate home equity loan for $20,000 at 8.89%, which was the average rate for 15-year home equity loans as of October 16, 2023. Using the formula above, the monthly principal and interest payments for this loan option would be $201.55.
If your application is turned down, it's likely to be because you don't meet lenders' home equity loan requirements in one of these areas: Available equity: You typically need more than 20% equity built up to qualify for a home equity loan. Credit score: Few lenders will approve you if your score is below 620.
If you have outstanding debt on a credit card, a personal loan, student loans or other debts, consolidating with a home equity loan could make it cheaper to pay them off. Plus, a home equity loan is a fixed rate, so your payment will always be the same.
Home equity loans can be an enticing option if you're a homeowner who needs to borrow money. They tend to have lower interest rates than those of personal loans and credit cards, and their fixed monthly payments can help you manage your budget. However, they also have downsides to consider.
Past Bankruptcy or Foreclosure
Having a bankruptcy or foreclosure on your short- to mid-term credit history will likely make it difficult to qualify for all types of loans, including HELOCs. These marks against your creditworthiness are not permanent, but they also don't vanish overnight.
In October of 2023, Bankrate data showed rates were averaging 8.75 percent on home equity loans and 9 percent for HELOCs. There is one bright spot, though: If you use a HELOC or home equity loan for housing-related repairs or remodels, the interest can be tax-deductible. That can reduce the real cost of your financing.
What is a high debt-to-income ratio for a home equity loan?
Increased Debt-to-Income Ratio
Home equity lenders typically require DTI ratios of 43% or less. You can calculate your DTI ratio by dividing your gross monthly pay by the sum of your minimum monthly payments on loans, credit cards and other consumer debt, then multiplying by 100 to get a percentage.
A HELOC stands for a home equity line of credit, and if you decide to take one out to access funds, it could directly affect your credit score. Additionally, taking out a HELOC requires a lender to run a hard inquiry—this can temporarily decrease your credit score by a few points.
If the value of your home drops significantly, your lender may decrease your HELOC limit to reflect the reduced equity or freeze your HELOC account altogether. A housing market crash may also cause you to default on your HELOC if you owe more on your home than it's worth.
While having an unused HELOC can be advantageous in many ways, it's essential to be aware of the potential costs. Some HELOCs come with annual fees or maintenance fees, which you might still have to pay even if you don't use the credit line. The fees you could incur, even with an unused HELOC, include: Inactivity fees.
Example 2: 15-year fixed home equity loan at 9.07%
As of December 21, 2023, the average national rate for a 15-year loan was nearly the same as for a 10-year loan: 9.08%. With that rate and term, you'd pay $764.27 per month for the loan.
References
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