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HELOC vs Home Equity Loan

HELOC vs Home Equity Loan

One of the biggest financial advantages of homeownership is building equity over time. This equity can be used as collateral to access funds without selling your property. For homeowners looking to tap into this value, two popular borrowing options are a HELOC (Home Equity Line of Credit) and a Home Equity Loan.

Much like how businesses use a line of credit to handle cash flow or seize opportunities, individuals can use their home equity in similar ways. A HELOC acts like a credit card, offering a revolving credit limit, while a home equity loan provides a lump sum with fixed repayment terms.

If you’re unsure which option suits your needs better, this article breaks down the key differences between HELOC vs Home Equity Loan to help you make an informed choice.

What is HELOC?

As the name suggests, HELOC or home equity line of credit is a revolving credit line that gives an individual access to a pool of money. These loans are an excellent option to cover ongoing costs, and there are two phases involved—the drawing phase and the repayment phase. 

Here, the borrower can draw for around ten years, and the lender has a credit line allowing them to borrow funds whenever the individual requires. The repayment phase is more extended and lasts between 10 and 20 years in most cases. 

Pros & Cons of HELOC

Pros 

  • Ability to withdraw money as required till the limit expires.
  • Pay interest only for the amount withdrawn.
  • Flexible repayment options, with the option to convert a part of the liability to fixed rates.
  • Interest rates can reduce if your credit score improves or if the overall market rate falls.

Cons

  • Interest rates can spur up suddenly because of external factors or if your credit score goes down.
  • Because of variable rates, payments fluctuate.
  • Can push individuals toward impulse spending.

How Does a HELOC Work?

HELOCs share similarities with credit cards and equity loans. While the loan amount is dependent on the equity in the home of the individual, similar to how equity loans function, the forwarded amount is a revolving credit identical to how credit cards go about their business. The collateral here is the home, which means that if an individual misses repayment beyond a limit, the lender can attach the house to get their money back. 

A HELOC inadvertently comes with a variable home loan interest rate. It means that the interest can change over the years, which affects the periodic amount due. An individual can find it inaccessible, but some lenders offer fixed HELOC interest rates, but it also depends on their creditworthiness, reputation, and the sum in contention. 

If an individual is in the draw period, they are most likely to only repay the interest for that duration. However, as soon as the period expires, the repayment amount grows significantly, including the interest.

Let us consider an example:

Mr. Y has a home with an appraised value of Rs. 40 lakh and has a pending home loan amount of INR 10 lakh. He has applied for a HELOC with the said home as collateral. The lender approves the loan to the tune of 60% of the home equity with a draw period of 10 years. It means that Mr. Y can withdraw a maximum of INR 18 lakh ((40-10) lakh x 60%) during the loan term. 

Depending on the amount withdrawn and the date of withdrawal/s, the lender will levy interest on the amount forwarded. 

What is Home Equity Loan?

A home equity loan is a fixed-term loan that a lender grant based on the value of the equity in the borrower’s home. Also referred to as second mortgages, it means that the borrower can borrow a certain percentage, usually limited to 85% of the difference between the value of the home and the outstanding loan balance against it. 

The home equity loan offers the borrower a lump sum with a fixed interest rate. It also includes a schedule of fixed payments for the loan’s term. 

Pros & Cons of Home Equity Loan

Pros

  • Get a lump sum amount upfront
  • An option to pay a fixed monthly payment over a predecided period
  • Secure a lower home equity loan rates interest than personal loans or credit cards because of collateral being involved
  • An option to choose a longer repayment term of up to 30 years

Cons

  • Chances to lose the home if payments are not made
  • If too much equity is used at once, it can work against them if the property value declines significantly.
  • Inability to raise more funds in an emergency

How Does Home Equity Loan Work?

Here, the individual’s equity in their home serves as collateral. Also known as a second mortgage, it only works if there is enough equity in the house. The loan amount is usually limited to a certain percentage, say 80% or 85% of the property’s appraised value, and is based on several factors. These factors comprise the CLTV (combined loan-to-value) ratio and the individual’s credit score and credit history.

In most cases, a home equity loan includes loan processing, loan origination, appraisal, and recording fees, with many lenders choosing to charge a nominal prepaid interest (1% or lower). In most cases, the interest rate is fixed and won’t change during the loan term. Also, equity loans are rigid with their repayments which are fixed and apportioned in equal amounts over the life of the loan. 

Let us consider an example: 

Mr. X has a home worth Rs. 30 lakh and borrowed Rs. 25 lakh as a home loan. The individual still owes Rs. 15 lakh, whereas the property value has appreciated to Rs. 34 lakh.

In this case, the home equity value would be Rs. 19 lakhs (34 lakh – 15 lakh). 

HELOC vs Home Equity Loan (Table)

Here are the key differences between home equity loan vs line of credit:

ParticularsHome Equity LoanHELOC
Interest rateFixedVariable
Amount forwardedLump sum at the beginningLine of credit
RepaymentFixed repayments periodicallyAmount changes over time
Repayment termStarts as the lump sum is disbursedRepayment is limited to interest-only during the draw period. Principal repayment starts in the repayment phase.
Best forLump sum capital needs (for example: starting a business)Periodic cash requirement (for example: for managing the working capital needs of a business during an emergency)

Now that you are aware of differences between home equity loan vs line of credit, let us understand how to apply.

How To Apply for a HELOC or Home Equity Loan?

Once you’ve done a comparison of HELOC vs home equity loan for your specific needs, it’s time to begin the application process. Here’s a simplified five-step guide to help you through it:

  • Step 1: Review Lender Requirements: Before anything else, understand what your lender expects. Most lenders require that you maintain at least 15–20% equity in your home. Lenders will also evaluate your credit score, income, and existing debt obligations to ensure you’re financially stable enough to handle the loan.
  • Step 2: Gather Required Documents: To proceed smoothly, keep the following documents ready:
  1. A valid government-issued ID (such as a driver’s licence, Aadhaar, or passport)
  2. Income proof like salary slips, W2s, tax returns, or retirement income statements
  3. Details of your current property expenses, including mortgage statements, property tax bills, and home insurance documents
  4. Step 3: Fill Out the Application: Most lenders now offer a digital application process that is quick and user-friendly. This form collects essential details about your income, property, and loan requirements. Once submitted, the lender will assess your eligibility and loan amount.
  5. Step 4: Get Your Home Appraised: A property appraisal determines your home’s current market value, which in turn affects how much equity you can borrow against. In many cases, a desktop appraisal (using online data and recent sales of similar homes) is sufficient, making the process faster and more convenient.
  6. Step 5: Pay Closing Costs and Access Funds: Closing costs can be paid either upfront or added to your loan amount. Paying upfront helps you avoid extra interest, but if that’s a strain on your budget, rolling it into the loan is a common option. After closing, you’ll either get a lump sum (home equity loan) or access to a credit line (HELOC).

What is a good alternative to a HELOC or a home equity loan?

While HELOCs and home equity loans are good options for those looking to use their home equity as collateral, here are some options for those not willing to risk their homes for getting a loan sanctioned: 

Personal line of credit

For all those looking for a HELOC alternative, a personal line of credit would serve their purpose right. Lenders offer it to people with good creditworthiness, and it is a revolving credit account that doesn’t have any collateral backing it. While these allow withdrawal similar to HELOCs, the repayment period is significantly shorter, sometimes a few months or up to five years. 

Personal loan 

An unsecured loan is similar to a home equity loan but without the home equity backing it. It is a collateral-free offering that carries a higher interest rate. The amount is paid upfront as a lump sum and depends on the individual’s creditworthiness and a fair to good credit score. While the loan period is shorter with a personal loan, the individual has the option to renew it periodically. 

What are the requirements for a HELOC or a home equity loan?

Here are the criteria set by most lenders for approval of a HELOC or a home equity loan:

  • Fair to good credit score (preferably over 600)
  • Home equity of 20% or more
  • A history of stable and verifiable income

How to choose between a HELOC and a home equity loan?

Now that an individual understands the pros and cons of both the options and how they function, it is vital to make the right choice for their specific use case. 

Here are the situations when a home equity loans would suit them better: 

  1. If the individual requires a lump sum upfront for any specific need
  2. If they prefer a fixed-interest loan 
  3. If the individual requires a precise sum to borrow
  4. If they have a good credit score and can secure a loan at a lower interest rate

Here is when a HELOC is more likely to suffice:

  1. The individual requires frequent small forwarding instead of having to settle a lump sum upfront
  2. They have no idea of the total loan amount they would require over time
  3. If the individual has a strong credit profile, preferably a credit score over 680
  4. If the individual needs a low-interest loan against their home equity

Conclusion

HELOCs and home equity loans are terrific options for those willing to use their home equity as loan collateral. Unfortunately, with the recent pandemic incursions, some lenders have tightened their qualifications, which has meant that these loans are harder to come by. 

When choosing between a home equity line of credit vs loan on home equity, there are clear advantages for each. These cater to specific use cases and are an excellent second loan option. So, whether an individual is looking to renovate their home or improve it, these options suffice. 

If an individual is short of funds or cannot get any of these loans approved, Tata Capital is there for all loan-based needs. Avail a home loan anywhere between Rs. 5 lakhs and Rs. 5 crores with us at the most reasonable interest rates. 

Plus, we offer tailor-made options for helping individuals purchase or construct a home with the ability to choose EMIs at their convenience. Check your home loan eligibility criteria and home loan EMI with our calculators.

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FAQs

Can I switch from HELOC Credit Line to a fixed-rate loan?

Yes, many lenders allow conversion of all or part of your HELOC balance to a fixed-rate loan, offering rate stability and predictable monthly payments.

What happens if I can't repay my home equity line?

Failure to repay your HELOC can lead to penalties, damaged credit, and potentially foreclosure, as your home is used as collateral for the borrowed amount.

In fixed-rate vs HELOC, when should I choose HELOC?

Choose a HELOC when you need flexible access to funds over time, especially for ongoing expenses like renovations, rather than a one-time large expense.

How long do I have before I need to start repaying my HELOC taken amount?

Most HELOCs have a draw period of 5–10 years during which you pay interest only; repayment of principal usually begins after this period ends.