HELOC Vs Mortgage: Everything That You Need to Know
Have you ever wondered what the differences are between HELOCs and mortgages? Both of them are offered by lenders. Which is the best? What type do you need? Are there pros and cons to each of them? We’ll go over this here, as we look at HELOC vs mortgage.
HELOC vs Mortgage
In order to truly understand the differences between these two types of loans, you first need to know what they are. A HELOC is also known as a home equity line of credit. This means that it’s a loan that you can take money out of, pay it back, and then take more from it again. That’s the simplest way of explaining it. A mortgage, on the other hand, is loaned out in one lump sum and then paid back over time. You can’t go back to it again and again, taking out more money each time.
Terms and Other Details
When you take out a mortgage, you need to make a down payment to show that you can afford to buy the property. Plus, there are fees (known as points) that are based on a percentage of the amount of the loan. Once you take out the mortgage, you’ll have between 20 to 30 years to pay it back (this is standard) or less time, depending on the terms. In most cases, the interest rate stays the same. This is called a fixed rate mortgage. There are other types, but this is the most popular.
A HELOC works slightly differently. These loans are placed into an account that functions kind of like a checking account. Some even have debit cards attached to them. You don’t need to make a down payment or pay any sort of origination fee, because the loan is based on the amount of equity that you have available on your home. Your equity is the amount that your home is worth minus the remainder of your mortgage loan. This is what your HELOC will be, depending on factors like your credit score, whether or not the houses in your neighborhood are increasing in value, and what your debt to income ratio is. Some lenders allow you to take out a HELOC for the full amount of equity, while others don’t. It all depends. The interest rate of HELOC fluctuates based on the federal interest rate. Some lenders add on between five to six percent of that rate. This will be capped at a certain amount, but you can assume that the interest will vary over the life of the loan.
The Repayment Process
When you go to repay your mortgage, you’ll find that this is a very simple process. You just need to make the monthly payments based on the amount on the coupon. Since many mortgages don’t have early payment penalties, you can pay several months in advance, add on extra amounts that will go towards the principal, and so on. It’s easy to understand exactly where you’re at with a mortgage.
A HELOC is a bit different. You have the draft phase, which will last for between ten and 20 years. This is when the loan is open and you can remove money from it. During this period, you just have to pay the interest amounts and you’ll keep the loan in good standing. Of course, you can pay on the principal as well if you want to. It’s up to you.
Once the draft phase ends, the HELOC enters standard repayment. This means that you’ll be paying more on it each month because you have to pay back the entire amount of the loan – the interest and the principal. The payment term for this can vary as well, and it depends on a number of factors, all of which will be outlined in your initial loan document.
The Purpose of Each Loan
In addition to the many differences explained above, the purposes of each loan vary quite a bit. A standard mortgage loan is used to pay for the purchase of a house. (Yes, there are second and even third mortgages, but we’ll omit them in order to keep this simple.) A HELOC, on the other hand, can be used for many different reasons. You can use a HELOC to pay for a home remodel, to purchase a vehicle, to pay for college for your children (if their student loans fall short), to pay off credit card debt, and even to have some emergency funds on hand, just in case. There are many other reasons as well – too many to mention here!
As you can see, a mortgage and a HELOC are very different. Each has a very specific purpose, and you can have one of each of them at the same time, depending on your equity, credit score, and debt to income ratio.