What is a Home Equity Line of Credit?

February 14, 2020 | Mission Fed

Father and mother playing with their daughter in their new home.

Becoming a homeowner is a great step in the right direction in helping to secure a better financial future for yourself. No longer do your monthly rent checks go into someone else’s hands — now, by paying off your mortgage, you are essentially investing in yourself. But, with this financial investment comes higher monthly payments and unforeseen costs, and new homeowners often find themselves strapped for cash.

If you are familiar with this scenario, you may have also heard about home equity loans, or a home equity line of credit.

To understand and distinguish the differences between a home equity line of credit (or HELOC), and a Home Equity Loan and how they can help with your current financial situation, read on.

Home Equity Loan vs Home Equity Line of Credit

First things first, let’s sort through the definitions. A home equity loan, (also known as a second mortgage) allows you to pull out funds as much as the value of your home.

  • What is a Home Equity Loan? Pulling out a second loan on your home can be done as a one-time lump sum at a fixed rate, and come with an outlined repayment period. This should only be used when absolutely necessary, as the rates will likely be higher than your first mortgage, accruing more interest over the years.
  • What is a Home Equity Line of Credit? – Another option is to use your home as a line of credit. This will offer access to funds through your home’s equity. The interest rates are typically variable and lower.

Difference in Accrued Interest

If you spend $20,000 from a maximum line of credit of $200,000 using a HELOC, you only accrue interest on the $20,000. Whereas, if you spend $20,000 on a home equity loan of the same maximum value, you will be accruing interest on the total loan: $200,000.

The main difference between an HELOC and a home equity loan is in the interest you pay. On a home equity loan, you pay interest on the entire amount loaned. But if you choose to apply for a HELOC, you only pay interest on the credit you use. Both options operate under the idea that your house is the collateral for the deal. Many people like using HELOCs because they act as a line of credit, where you can pull funds from as needed.

Benefits of HELOC

Because HELOC acts like a brand-new credit line (with low-interest rates), there are many benefits to using this option. Here are some items to consider with a home equity line of credit:

  • Making upgrades or improvements to your home – Many homeowners will tap into this new line of credit when the money is going directly back into the home and raising its value. By adding something like solar, or renovating a kitchen or bathroom, this will increase the value of the home. While the value added to the house through upgrades and home improvements do not always recover the upfront payment, they increase the standard of living and bring value in other ways over the years.
  • When you need a resource to tap into for years – One major difference between home equity loans and HELOC is the lump sum versus incremental payment options. Loans will offer a one-time money relief, as opposed to HELOC, which can be a resource to tap into during the draw period when needed.
  • Lower interest rates than credit cards – In many situations, a HELOC is preferred to borrowing money against a credit card, which has steep interest rates and hidden fees.
  • Debt consolidation – In the case where you may have student loans, credit card debt, and other loans with high-interest rates, you can consolidate all of these into one account. This is a reasonable option when the interest rate against your home is lower than your current loan programs.
  • Funding expensive single purchases – Vacations, a new car, a new fitness studio in the house — these are all expensive one-time purchases. To reimagine the way this will affect your bank account, you can pay it off incrementally with HELOC.

Home Equity Line of Credit Requirements

As the name implies, one must have a home in order to qualify for a home equity line of credit. But, this is not the only HELOC requirement. Here is what you need to know before applying.

  • You will need a strong credit history to apply for a HELOC. Generally, a credit score of 620 is recommended, but the higher, the better.
  • Your debt-to-income ratio (DTI) should be lower than 50%. That means you are making more than twice what you have to pay each month in bills.
  • Most financial institutions require that you own at least 15% to 20% of your home before opening a separate line of credit against it.

Two Types of HELOC

There are two common types of credit lines, each coming with a different method of payment.

  • Regular HELOC Loans – A HELOC is a line of credit that is not a credit card, but works similar to a credit card; where you can borrow a certain amount against the equity of your home for a certain amount of time (draw period). You will pay minimum monthly payments after the draw period for both the principal and interest.
  • Interest-Only HELOC Loans – As a secondary option, you can choose to only pay the interest on the money you draw from your line of credit in the beginning of your loan. The minimum monthly payment during the draw period only covers the interest on the loan.

Mission Federal offers both options, and will work with its members to decide which payment plan makes the most sense for their situation.

Mission Federal HELOC Loans

For local San Diegans, they can rely on Mission Federal to offer low, affordable rates for their home equity line of credit. Stop by your local Mission Fed branch, or call us today.

How to Lower Interest Rates on Your Credit Line

Whether you have a home loan, or a home equity line of credit the idea underpinning a loan of any form is, that you gain the money now and are responsible for paying the principal back with interest. Thus, the objective is to show that you are dependable. How does one do that? Increase your credit score.

  • Paying all bills on time is a surefire way to increase your credit score over time.
  • Having multiple lines of credit available (and paying off each one monthly) is another way to boost your score.
  • Another method is to lower your outstanding debt, or apply for an increase in your credit line.

Enjoy Your New Line of Credit

Whether you are considering reinvesting in your home with a big project, or you want to consolidate all of your outstanding finances under one umbrella, a home equity line of credit is an option. Not only can you avoid exorbitant credit card rates, but you can also avoid hidden fees and immediate costs.

With Mission Federal’s home loan program, you can have these benefits at low rates. To learn more about the different home loan options available, visit our website or contact a lender from Mission Fed Credit Union today.

The content provided is intended for informational purposes. Mission Federal Credit Union disclaims any liability for decisions you make based on the information provided. References to any specific commercial products, processes, or services, or the use of any trade, firm, or corporation name in this article does not constitute endorsement, control or warranty by Mission Federal Credit Union.

Sources:

National Bureau of Economic Research. Understanding the Solar Home Price Premium: Electricity Generation and “Green” Social Status. https://www.nber.org/papers/w17200.pdf

The Federal Reserve Board. 5 Tips for Improving Your Credit Score. https://www.federalreserve.gov/pubs/creditscore/creditscoretips_2.pdf

NerdWallet. Requirements for a Home Equity Loan and HELOC. https://www.nerdwallet.com/blog/mortgages/what-are-the-requirements-for-a-home-equity-loan-and-heloc/

Mission Fed

Mission Fed

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