Home Equity Loan vs Line of Credit Pros and Cons

Using the equity in your home to pay for substantial renovations on your property or consolidate debt could be a great option for many homeowners. How you access this equity, however, depends on your specific financial situation and needs. To help you make the right decision, we’re discussing home equity loan vs. line of credit pros and cons.

What Is Home Equity?

The equity you have in your home is a fluctuating figure representing the difference between your current mortgage loan balance (plus any existing HELOC or home equity loan balances) and your property’s current value. 

For example: If your home is worth $400,000 and your current mortgage balance is $300,000, you have a $100,000 equity stake in your property. 

There are two primary ways home equity is built:

  • Part of your monthly mortgage payment goes toward the principal loan balance.
  • The value increases due to improvements and changes in the real estate market.

Accessing Your Home Equity

Just as there are two distinct ways to build equity, there are also two primary ways of accessing your home’s equity; Through a home equity loan or a home equity line of credit (HELOC). Let’s take a look at the home equity loan vs line of credit pros and cons to see which might be best for you and your financial needs.

Home Equity Loan Pros and Cons

After qualifying for a home equity loan, you will receive your loan amount as a single lump sum and begin to make monthly repayments immediately on the entire amount borrowed. Home equity loans typically have a fixed interest rate, meaning your monthly payment — including the principal and interest — will remain the same throughout the life of the loan.

Pros:

  • Fixed monthly loan payments offer predictability with which to plan and budget for today and the future.
  • Receiving funds in a lump sum could be beneficial if you plan to use the money for one thing or a major project with a bill due in full. 
  • The fixed interest rate will not change with market conditions during the life of the loan.

Cons:

  • Home equity loan payments begin immediately.
  • Payments are calculated on the entire borrowed lump sum amount whether or not you use it all.

HELOC Pros and Cons

A HELOC is a revolving line of credit from which you can borrow at any time during the “draw period,” which typically lasts 10 years. Each time you make a principal payment on your HELOC, the line of credit replenishes much like when you pay down your credit card balance, meaning you will have more money accessible to borrow again. 

Offering competitive interest rates and an online application process, Prosper’s HELOC program lets you see your rate and borrowing limit instantly without impacting your credit. Now let’s take a look at the pros and cons of home equity lines of credit in general.

Pros:

  • Borrow only what you need, when you need it (like a credit card) during the draw period (typically 10 years).
  • Ability to borrow from the home equity line of credit repeatedly during the draw period.
  • Payments will only be due on the portion of the line of credit you use.
  • Lower, interest-only payments may be available during the HELOC draw period.

Cons:

  • Possibility of overspending with a revolving line of credit.
  • Variable interest rate could rise due to economic and market conditions.
  • Fluctuating monthly payments could make budgeting a challenge.

Additionally, there could be home equity line of credit tax advantages, although 2017 tax law changes made this more complicated than before. In short, interest on home equity money borrowed after 2017 is, according to Investopedia, “Only tax-deductible for buying, building, or improving properties.” Because this particular tax law is complicated, you should consult a tax professional before applying for a HELOC to determine whether you may be eligible for any home equity line of credit tax advantages.

Read more: Top 5 HELOC Questions Answered

How Does a HELOC Affect Your Credit Score and Mortgage?

If you’ve been a homeowner for a number of years, you may have built up some equity in your property. Now, you may be able to use that equity in your home to open up a home equity line of credit as a means of paying for renovations, debt consolidation or big-ticket items. But before you do, you could be wondering, “How does a HELOC affect your credit score?”

First, it’s important to know that a HELOC is a line of credit based on your home’s equity, and it uses your home as collateral. The most common ways to establish an equity stake in your home are to:

  • Make timely mortgage payments.
  • Make extra principal payments to your mortgage.
  • See the value of your home increase thanks to real estate market conditions.

A HELOC Works Like a Credit Card

While you may be able to access your home’s equity to spend and re-spend in any way you’d like, a HELOC is revolving debt much like a credit card, with more money becoming available as you pay off what you’ve spent. Unlike credit cards, though, home equity lines of credit have a predefined draw period, typically lasting 10 years. During this time, you can access money for home repairs, dream vacations and other big-ticket expenses, among other HELOC uses. 

While you’re drawing from the HELOC, you may make interest-only monthly payments on what you’ve drawn from the line of credit. At the end of this draw period, you will begin the repayment phase with principal and interest payments spread out over 10–20 years — although you’ll likely be allowed to repay faster or in full at any time.

How Does a HELOC Affect Your Credit Score?

While a HELOC does act similarly to a credit card, its effect on your credit score is different.

At Prosper, we only run a soft inquiry on your credit when you check your HELOC rates to determine how much you could access. But does a HELOC affect your credit score? The answer is yes and no.

Yes, opening and using a HELOC will affect credit score, but whether the impact is negative or positive will depend on how well you manage your line of credit. You could expect to see a credit score increase if you:

  • Make payments on-time to your home equity line of credit.
  • Keep your HELOC balance low.

To that last point, using less of your available HELOC will improve your credit utilization rate (the percentage of available credit you are using at any given time). Because this figure makes up nearly a third of your credit score, most financial experts advise keeping your credit utilization rate at or below 30%

For example: If you have a $20,000 HELOC, you should try to keep the balance below $6,000. With your good credit score in mind, you may want to open up a HELOC for significantly more than you plan to use.

Conversely, the opposite is true. A HELOC will impact your credit report negatively if you fail to make your payment on time or at all, and if your revolving balance is consistently high in relation to the overall available money to draw from. This will result in a credit utilization rate that may damage your credit score and make it harder to borrow in the future.

More Frequently Asked Questions About HELOCs

Now that you know how a home equity line of credit can affect your credit score, let’s take a look at two more questions many potential borrowers often have about HELOCs. 

What Is a Lien?

According to Investopedia, a home lien is a term for a legal claim placed on a home. In real talk terms, a lien on your home is what happens when you take out a mortgage and HELOC because you’re borrowing against your home. The lenders therefore have a legal claim to the property should you fail to make your payments or pay off the loan and line of credit during the agreed upon term. While a lien may sound scary, it likely won’t be something you have to worry about, assuming you pay your mortgage and HELOC on time.

Can I Have a HELOC and a Mortgage at the Same Time?

Absolutely. Many homeowners are still paying on their original mortgage when they open a HELOC to access some of the equity they’ve built up in their home. The only noticeable impact for you is that there will now be multiple monthly payments due, so it is crucial to understand your budget and what you can afford to spend. 

Additionally, when you have both a mortgage and a HELOC, it could mean there are multiple lenders with a lien on your home. However, providing you make your payments and pay off the mortgage and line of credit, there is no downside to having both open simultaneously. 

Curious How Much Equity You Can Access?

Hopefully, you now know how to answer the question, “How does a HELOC affect your credit score?” Now, if you’re ready to see how much equity you can access, use the Prosper HELOC calculator today to check your rate and available line of credit amount with no impact on your credit score.

Read more: HELOC vs. Second Mortgage: What’s The Difference

Introducing Prosper’s New eBook: 4 Ways to Use a Home Equity Line of Credit (HELOC)


Today we are excited to announce the release of our new eBook, 4 Ways to Use a Home Equity Line of Credit (HELOC), which is now available to download by clicking this link: 4 Ways to Use a Home Equity Line of Credit (HELOC) eBook.

Created to address confusion around HELOCs, this free resource covers everything you need to know, including:

  • What a home equity line of credit is and how it works
  • The advantages of a home equity line of credit
  • How to use a HELOC for home improvements, debt consolidation, major purchases and even as an emergency fund

You’ll also find links to other helpful resources, including Prosper’s easy-to-use HELOC calculator, throughout this 10-page guide.

To get your free copy of 4 Ways to Use a Home Equity Line of Credit (HELOC) today, follow this link. Not in the mood to download a file? We’ve got you covered. We’ve laid out the eBook content below, if you’d prefer to read it that way.

What Is a Home Equity Line of Credit (HELOC)? 

A home equity line of credit, or HELOC, is a revolving line of credit based on the equity you’ve built up in your home. A home’s equity is the difference between the value of your home and your mortgage balance. A HELOC works like a credit card but because the line of credit is secured by your home, you can access more money at a lower interest rate than a credit card or personal loan. Keep in mind that in exchange for the lower rate, your home acts as collateral for the line of credit. 

It’s also important to know that with a HELOC, there’s a defined draw period from which you can borrow (usually 5–10 years). Once the draw period ends, you enter the repayment period (typically 10–20 years).

How Should I Use a HELOC? 

In short, you can use the funds from a HELOC for any purpose. While home improvements are among the most common uses (remember: your home is the collateral for the HELOC), you may utilize your home equity to consolidate debt or finance a large expense. 

However, before you apply, it’s important to know what you want to use your HELOC for. Here are the four smartest ways to use a HELOC. 


RELATED ARTICLES 

What is a HELOC and How Does it Work? 

Home Equity Line of Credit vs. Home Equity Loan: What’s the Difference? 

Is a HELOC a Good Idea? Great Ways to Use a HELOC During COVID-19 

How a Fixed-Rate HELOC Works


1. HELOC for Home Improvements


While there are a number of ways to pay for your next home renovation project, as a homeowner with equity, a home equity line of credit (HELOC) may be the best way to finance your home improvements. Here’s why: 

A HELOC offers increased flexibility of funds, so you can use your credit when your projects are completed and invoices need to be paid. 

You’ll have less stress as delays and unexpected costs in house projects are common. With a HELOC, you can draw money when you need should costs and deadlines change. 

Not sure which projects you want to start on first? A HELOC allows you to gradually withdraw money to pay in stages, as the work is booked and completed. 

During the draw period, you may be given the option to make interest-only payments. 


RELATED ARTICLES 

HELOC: The Best Way to Finance Home Improvements 


2. HELOC for Debt Consolidation

Homeowners who are struggling with high-interest debt may be able to use their home equity to consolidate balances. A HELOC can offer you access to a larger sum of money as an option to consolidate your debt. Here’s why a HELOC could be useful for debt consolidation: 

Lower Interest Rates: A key benefit to a HELOC is you may be able to borrow money at a lower interest rate than you pay on your current debt. The lower the rate, the more you’ll save as you pay off your consolidated debt. 

One Easy Payment: Instead of keeping up with multiple payment due dates, consolidating your debt with a HELOC helps you manage it all with one easy monthly payment 


RELATED ARTICLES 

How to Use Home Equity for Debt Consolidation 


3. HELOC as an Emergency Fund 

5 If you’re in need of cash fast, a home equity line of credit may be your best solution as a homeowner. A HELOC may offer a variety of benefits when you need access to money quickly, such as when covering an emergency situation like a roof leak or medical bill. 

A HELOC allows you access to a revolving line of credit and usually, a HELOC offers a lower interest rate and a higher line amount than credit cards or personal loans. But it’s important to understand you are using your home as collateral. You have to be mindful to only borrow what you can afford to pay back. 


RELATED ARTICLES 

How to Improve Your Financial Health During COVID-19


4. HELOC for Major Purchases 

Need to make a major purchase, but you don’t have enough in your bank account to cover the upfront cost? A HELOC may help out in that situation. Because, as stated before, a home equity line of credit can provide you access to a large sum of money, depending on how much equity you have built in your home. 

Here are some big-ticket items a HELOC can help you cover: 

  • College
  • Car
  • Vacation
  • Wedding

RELATED ARTICLES 

Wondering What a HELOC Will Cost? Try Our HELOC Calculator


Conclusion

Now that you know the smartest ways to use a home equity line of credit, the next step is to figure out if it’s the right option for you. While there are many advantages to a HELOC, if you aren’t able to pay on time, your home is on the line. That’s why it is so important to assess your financial wellness and use the funds appropriately so you can pay back the amount you owe in the time allotted. 

If you feel certain a HELOC is right for you, you may want to check how much you can borrow using a HELOC calculator. From there, you can see how much you can borrow and begin the application process. 


RELATED ARTICLES 

How to Get a Home Equity Line of Credit (HELOC) 

HELOC Pros and Cons: is a Home Equity Line of Credit Right for You? 

Your Top 5 HELOC Questions Answered

How to Apply for a HELOC Online, Plus 5 Benefits of an Online HELOC

HELOC stands for a home equity line of credit, and it works much like a credit card with a credit limit based on the equity you’ve built up in your home and other information from your credit profile. A HELOC is secured by your home. A lender will approve you to borrow up to a certain amount (up to $1 million with an online HELOC through Prosper) depending on the equity you have in your home and your credit profile. As you pay back what you use, you can continue to borrow from your revolving line of credit.

Applying for a HELOC online may be easier compared to the traditional HELOC application process. You can apply from the comfort of home and receive the funds directly into your bank account. This makes an online home equity line of credit the consumer-friendly option for homeowners looking to use the equity they’ve built up in their home for renovations, debt consolidation or any other purpose. 

5 Reasons to Apply for a HELOC Online through Prosper

There are many reasons why an online HELOC could be your best option when looking to utilize and access the equity in your home. Let’s look at some of the reasons to apply for a home equity line of credit online.

1. Applying Is Easy

An online application may be easier compared to traditional paperwork and an in-person trip to the bank. It can be completed in minutes, from wherever you are, simply by entering some of your financial information, such as your estimated home value and remaining mortgage balance.

2. See Your Offer Instantly

Applying for an online HELOC allows you to see your interest rate and credit limit instantly, without impacting your credit score because Prosper doesn’t use a ‘hard pull’ credit inquiry to check rates. The hard pull happens if you accept your offer.

3. Submit Your Documentation Electronically

Whereas a traditional HELOC may require physical paperwork to be submitted and signed, applying for an online home equity line of credit allows you to upload your documentation and sign electronically. 

4. Apply from Anywhere

Whether you’re still in bed, working at your desk or on vacation, you can apply for an online home equity line of credit from anywhere. There’s no need to drive to a bank branch or ever meet face to face with a lender, making an online HELOC a convenient way to access the equity you’ve built up in your home.

5. Save On Closing Costs

Some online HELOC lenders choose to cover the cost of closing on your line of credit. At Prosper, BBVA pays the closing costs1 for lines of credit between $10,000 and $500,000. Depending on the size of your line of credit, with an online HELOC through Prosper, these bank-paid closing costs could save you a significant amount of money.

Read more: Here’s Everything You Need To Know About Home Equity

1 Closing Costs: BBVA will pay for all closing costs on new home equity products with amounts ranging from $10,000 to $500,000. Credit requests for less than $10,000 or more than $500,000 shall be subject to actual closing costs incurred and permitted by law. To qualify for Bank-Paid Closing Costs, the borrower must complete a $10,000 draw requirement within 30 days which must remain outstanding for 90 days (not applicable in Texas). Bank-paid closing costs are subject to recoupment from borrower(s) if loan is paid off within 2 years (not applicable in Texas). Closing costs vary by state and typically range from $675 on a $10,000 credit line to $11,114 on a $1,000,000 credit line. Texas closing costs typically range from $935 to $7,339 depending on credit line amount.

HELOC vs. Cash-Out Refinance: What’s the Difference?

With every mortgage payment you make, you’re building equity in your home. And equity equals ownership. Once you’ve built up a significant amount of equity, you’re able to access that money and use the funds for any purpose you wish. How you access your home’s equity, however, depends on your needs.

The two most common options for accessing home equity are a home equity line of credit (HELOC) and a cash-out refinance. Let’s take a look at the differences between a HELOC vs. cash-out refinance and when each might make sense for your financial situation and specific needs.

What Is a HELOC?

A home equity line of credit is revolving debt. Based on the value of and equity in your home, a HELOC works much like a low-interest credit card. Once approved (usually for an amount up to 90% of your home’s value minus any outstanding mortgage balances), you may draw on the line of credit and use the money however you’d like. For example, you could use your home’s equity to take a dream vacation or perform home repairs, consolidate high-interest debt or assist with retirement budgeting.

As you accumulate a balance on your line of credit, you will make repayments toward the interest and principal. The similarities with how a credit card works continue because as payments are made during the draw period, your principal balance will decrease, allowing you to borrow more money. 

It’s important to note that a HELOC exists separately from your existing mortgage, and comes with its own terms and repayment schedule. For this reason, a HELOC is often referred to as a second mortgage. It’s secured by your home, meaning that if you fail to make payments, you may risk losing your home.

What Is Cash-Out Refinancing?

In short, a cash-out refi is a new mortgage that pays off your existing mortgage, giving you your home equity as a lump sum of cash (via a check or direct deposit into your bank account). 

The result of a cash-out refinance is a brand new mortgage loan and likely different terms than your original mortgage. This means a different interest rate, new monthly payment amount and possibly a longer remaining loan term to pay off the new mortgage completely. 

A cash-out refi could be the way to go if you need a fixed amount of cash immediately and would like to maintain one mortgage payment. A cash-out refinance may also be best if you don’t believe that you have the discipline for a revolving line of credit, which is open to subsequent borrowing.

HELOC vs. Cash-Out Refinance

When it comes to deciding between a HELOC vs. cash-out refinance, consider how and when you intend to use the equity from your home, and how long you will need to pay it back. 

A HELOC is a secondary loan product that is fluid in how you draw from it and how you pay it back. For example, if you don’t have a balance, there is no payment to make. This means that you will only have to pay back the portion of the HELOC you’ve used at any given moment. Typically, you’ll be able to draw from your HELOC over a 10-year period. After the draw period ends, the repayment period officially begins and you’ll no longer be able to withdraw from the HELOC. You will then have up to 20 years to repay the outstanding balance.

This is in stark contrast to a cash-out refi, which may immediately increase your monthly mortgage payment obligation for the next 10, 15 or 30 years. Let’s say your home is valued at $350,000 and your mortgage balance is $200,000. In this scenario, you have $150,000 of equity in your home, meaning you could refinance your $200,000 loan balance for $300,000, and receive the extra $100,000 in a lump sum. Your new mortgage will be for $300,000, and the interest rate and monthly mortgage payment will reflect that.

Key Features of a HELOC

  • Revolving debt to borrow and repay
  • Second mortgage with separate payment and interest rate
  • Payments due only on what you borrow
  • Variable payments during the draw period based on your line of credit balance (Payments may also vary if the HELOC has a variable rate feature including during the repayment period)

Key Features of a Cash-Out Refinance

  • Receive your home equity in a lump sum
  • Continue with a single, refinanced mortgage payment
  • Fixed payments
  • Longer terms may be available (for example, a new 30-year mortgage)

As you can see, there are several key differences between a HELOC vs cash-out refi. Before proceeding with either option you should consider your personal budget to determine what you can afford, and think about how and how often you will use the equity in your home. 

See How Much Equity You Can Borrow Today

When you’re ready, use our HELOC calculator to find out how much equity you may be eligible to borrow.

Read more: What are the Pros and Cons of a Home Equity Line of Credit?

How to Get a Home Equity Line of Credit with a Co-Applicant

If you’re a homeowner, you may have wondered how to get a home equity line of credit to access the equity in your home. While some may think that equity guarantees you access to a home equity line of credit, or HELOC, it does not mean you qualify for one. Learn more about what a HELOC is and how it works.

To qualify for a home equity line of credit, you’ll need more than equity in your property. Your current income level, credit score, and credit history all play a part. A lender may deny your HELOC application because of your income level or a red flag on your credit report.

While low income and poor credit could be roadblocks, there are ways to boost your HELOC approval chances. Here, we’ll cover how to get a home equity line of credit by applying with a co-applicant.

How to Get a Home Equity Line of Credit with a Co-Applicant

Your co-applicant, sometimes referred to as the co-borrower, is a trusted person who’ll share the liability for repaying your home equity line of credit. The co-applicant assumes equal ownership, payment and overall responsibility for the loan payments.

When considering how to get a home equity line of credit, you might seek out a reliable co-applicant with a solid credit history or a higher income than yours to improve your approval chances. Often, people choose to co-borrow with a partner or spouse to qualify for a larger loan than either one of the individuals could get on their own.

How a Co-Applicant May Help You Get a HELOC 

Having a co-applicant on a home equity line of credit application could benefit you as the borrower. A co-applicant with good credit could help a primary borrower with shakier credit get HELOC approval. A co-applicant may also help secure it at a lower interest rate. Not only that, you might be able to access more equity in your home by applying for a HELOC with a co-applicant.

If you’re thinking about how to get a home equity line of credit to consolidate debt or pay for home renovations, consider adding a trusted co-applicant to your HELOC application to increase your approval chances.

Read more: How to Get a Home Equity Line of Credit During COVID-19