If you’re thinking about tapping into your home equity, you’ve probably looked into a HELOC or home equity loan. Even though these loans are similar in terms of using your home as collateral, there are some fundamental differences you need to be aware of. It could be the difference between saving money on interest and getting the exact amount you need or being stuck with a loan you can’t pay back.
Approval Rates for Home Equity Programs
Yes, understanding the differences between loans is important, but so is understanding what you need to qualify. In order to be approved for a HELOC or home equity loan, you’ll need a fairly high credit score. The most common range for people who get approved is 720 or higher. But you can sometimes get approved with a score of 620-720. A lower credit score mean you’ll get a less favorable rate, however.
Lenders will also look at your debt-to-income ratio, or DTI. This number is used by lenders to predict how well you can manage your monthly debt payments. The higher this number, the more you’re viewed as a risk. If your financials aren’t in order and you go and apply for a loan, you could find yourself getting denied, or you could wind up with a higher interest rate.
Interest Rates for a Home Equity Loan
A home equity loan is typically a fixed rate loan and can sometimes be referred to as a second mortgage. Once you’re approved, you’ll get a set amount of money all at once which you’ll pay back over an agreed term – usually about 10 to 15 years. Since it’s a fixed rate loan, you’ll be making the same monthly payments throughout the term of your loan.
With a home equity loan, you’re making what’s known as amortized payments, where most of your payments goes towards interest initially, then builds up to where you are just paying off the principal at the end.
Interest rates on these loans vary, but they are tied to the federal funds rate. Since the federal funds rate has been rising this year and will likely continue to rise, home equity loan rates could keep going up fairly significantly. Currently, rates hover around 5% to 6% for those with the best credit scores, but could increase later this year. Usually, home equity loans tend to have higher rates than HELOCs because the rate is fixed and (usually) doesn’t change.
Interest Rates for a HELOC
A HELOC, or a home equity line of credit works much like your credit card. You get a revolving line of credit with a maximum loan amount, and you can borrow funds as needed. You’re approved for a certain amount, but you don’t need to borrow the maximum. In other words, you decide how much want to borrow and are only charged interest on how much you take out. The difference is that a HELOC is secured by your home, whereas a credit card is unsecured.
HELOCs start out with what’s known as a “draw period,” which lasts up to 10 years. During this time, you’re allowed to withdraw funds as often as you need and are paying interest only payments. When the draw period is completed, you’ll enter into what’s known as the repayment period which could last up to 20 years. You typically can’t withdraw any more funds during this time and will have to pay back interest and the principal amount in monthly payments.
HELOCs usually have variable rates so your payments vary depending on what the current interest rate is. Lenders may cap interest rates to prevent them from going up too high or dropping down too low. Currently, HELOC rates are around 5% to 6% which is a bit lower than a home equity loan. In an effort to drum up more business, some lenders offer low introductory rates as low as 3%. That rate will go up once the introductory period is over, usually after a year or two.
Which is the Right Option For Me?
There are no set rules for when to use a HELOC vs. a home equity loan. If you prefer knowing exactly what your payments look like month to month, then a home equity loan is probably best. That way, you’re not at the mercy of possible rate hikes. Yes, you could be paying more in interest than a HELOC, but it could be worth it for the stability of fixed monthly payments.
For borrowers who want to take out a short-term loan and plan on paying off within five years, a HELOC might be better. You can take advantage of the introductory rates and potential savings, and finish out the loan before there’s a chance of a rate increases. Also, for some home improvement projects, it may be a better idea to get a line of credit because you never know how much costs will add up to, particularly if you’re making improvements over a number of years. That being said, HELOCs aren’t always the cheapest. If you intend on staying in your home for a minimum of 5 years or more, a HELOC might cost more in the long run.
Alternative: Home Ownership Investments
While not everyone can meet the requirements to qualify for a HELOC or home equity loan, there are other options available to consumers, including a home ownership investment from a company like Unison. With the Unison HomeOwner program, you can unlock the equity in your home without getting a loan and with no monthly payments.
In a home ownership investment, a company like Unison invests alongside you in your home, sharing a portion of the future change in value of the home. In order to qualify for the Unison HomeOwner program, you usually need a credit score of at least 680. Your DTI should be less than 43%, and you should have a loan to value ratio of less than 80%.
No matter which option you choose, doing your homework ensures you know what you’re getting into. Remember, you’re using your home as collateral, so make sure you understand your risks before signing the dotted line.
Share this Post