I want to do some home renovations. What is the difference between a HELOC and a home equity loan?
Home equity loans and home equity lines of credit (HELOC) both let you take cash out against your home equity, but they work differently.
Remember that home equity means the difference between what your home is worth today minus what you still owe on your home. The part you still owe on the home is owned by the lender. But the other part — your equity — is yours. HELOCS and equity loans let you use the part you own for improvements.
Both types of loans are popular today because many homeowners have mortgage interest rates lower than today's rates. So they want to keep their original mortgage instead of refinancing.
For people who know exactly how much their improvement project will cost, a home equity loan has the advantage of a fixed interest rate and mortgage payments that won't change for the period of the loan. Borrowers get a lump sum at closing.
On the other hand, a HELOC is more like a credit card, but with much lower interest rates. You don't get a chunk of money all at once. Instead, you draw from your credit line to complete projects over a period of time — 10 years, for example. During this period, you only have to pay interest (but you can pay more). When the time period has expired, you pay both principal and interest.
HELOCs are also variable rate loans. That means your monthly payment will rise and fall according to the prime rate.
To get either loan, you need equity of at least 15 to 20 percent in your home. You need a debt-to-income ratio of below 50 percent. That means your monthly bills must be less than 50 percent of your income, the lower the better. You also need a credit score of at least 620, the higher the better.
