Are you eyeing some extra cash flow to help fix up your house or for another significant purchase but are puzzled by the credit options available?
Let’s discuss why HELOC rates often outperform personal lines of credit and why HELOCs are smarter for many homeowners looking to manage debt or fund big-ticket home improvements.
What is a HELOC?
A home equity line of credit, also known as a HELOC, is similar to a credit card but functions more like a second mortgage tied to the value of your home.
Imagine you have a credit card with a spending limit set by the bank. Instead, your limit is based on the value of your house minus any amount you still owe on it.
That’s essentially what a HELOC is—a flexible way to borrow money using the equity you’ve built up in your home as the credit limit.
How does a HELOC work?
HELOCs have two main phases—the draw period and the repayment period.
During the draw period, you can borrow money up to your limit, pay it back, and then borrow again, just like a credit card. This period usually lasts about 10 years.
After that comes the repayment period, during which new borrowing stops, and you start paying back the balance over a set number of years.
What makes HELOCs special is that they’re secured by your home. This means that if you can’t pay back the money, you could lose your house.
Because this security lowers the risk for lenders, you often get lower interest rates compared to unsecured loans, like personal lines of credit.
The Federal Reserve’s Interest Rates Page offers detailed insights into current interest rate trends that impact HELOC rates.
Key points about HELOCs
- Your borrowing limit depends on your home equity.
- Borrow, repay, and borrow again during the draw period. Repay the balance during the repayment period.
- Your home secures the loan, often resulting in lower rates.
HELOC example
Imagine owning a home valued at $300,000, and you still owe $200,000 on your primary mortgage.
Here’s how a HELOC would work for you:
- Calculate your equity: Your home equity is the current value of your home minus what you owe on your mortgage. So, $300,000 – $200,000 = $100,000.
- Determine your credit limit: The lender allows you to borrow up to 85% of your home equity. So, 85% of $100,000 = $85,000.
- Access to funds: You now have a HELOC set up with a limit of $85,000. You can borrow from this line of credit anytime, pay it back, and borrow again, just like using a credit card.
Home renovation scenario using a HELOC
- You decide to remodel your kitchen, which will cost $20,000. You can draw this amount from your HELOC, leaving $65,000 available for other uses.
- You paid back $5,000 towards the kitchen remodel costs over a few months. Now, you have $70,000 available again on your HELOC.
What is a personal line of credit?
A personal line of credit is a flexible financing option similar to a credit card. It allows you to borrow money up to a set limit, only paying interest on what you use, not the entire available amount.
This credit line is typically approved based on your credit score, income, and financial history.
This is typically ideal for people with good credit who need access to funds without using their home as collateral. However, the interest rates are usually higher than those of a HELOC.
Scenario using a personal line of credit
A personal line of credit is particularly useful for those who anticipate various expenditures over time and value the convenience of ready access to funds without the immediate need to draw on them.
Suppose you’re approved for a $50,000 personal line of credit. You plan to undertake several home improvement projects over the next year, including updating your kitchen and landscaping the backyard.
While you don’t need the funds immediately, having the credit line ready ensures you can manage costs as they come without delays.
Advantages of personal lines of credit
- Flexibility: It allows you to manage spending for multiple projects over time, helping you budget more effectively without needing multiple loans.
- No collateral: Ideal for renters or those who prefer not to use their home equity as collateral, providing financial solutions without tying up personal assets.
- Quick access: When project costs arise, funds are readily available, typically with simpler access than through loans that require extensive processing each time.
Differences between HELOCs and personal lines of credit
Here’s a straightforward chart comparing HELOCs and personal lines of credit.
It highlights the essential differences between the two, focusing on security, interest rates, repayment terms, and potential tax benefits.
This will help you quickly understand which option suits your financial needs better.
| Feature | HELOC | Personal Line of Credit |
| Security | Secured by home equity | Unsecured |
| Interest Rates | Lower (due to being secured) | Higher |
| Repayment Terms | Draw period followed by a repayment period | Flexible, often no fixed term |
| Potential Tax Benefits | Possible tax deduction from home improvement | None |
Why HELOC rates are lower than personal lines of credit
HELOC rates are lower primarily due to the secured nature of the loan, stringent eligibility requirements, and the substantial credit limits based on the home equity, all contributing to reduced risks for lenders.
Reasons for HELOC rates being lower
- Lowered risk factor: Because loans are secured by your home, the lender can reclaim money through the property as collateral.
- Credit availability: Credit limits on HELOCs can be much higher, determined by home equity.
- Market factors: HELOCs are generally safer investments than unsecured loans for lenders, allowing for lower HELOC rates for consumers.
- Eligibility requirements: Using HomeEQ’s criteria, factors like credit score, property type, and financial history are stricter, reducing lender risk and enabling lower HELOC rates.
Secure competitive HELOC rates with HomeEQ
While personal lines of credit and HELOCs offer revolving credit, the underlying differences in interest rates and credit requirements are significant.
HELOCs generally offer lower interest rates due to the home equity serving as collateral. However, they come with the risk of losing your home if you default.
Personal lines of credit are more accessible but typically come with higher interest rates.
Ultimately, the best choice depends on your financial situation, creditworthiness, and specific needs. Carefully considering these factors will help you determine the right option for you.
HomeEQ’s streamlined digital application process makes applying for a HELOC easier than ever.
Our competitive HELOC rates and quick turnaround for funding make HomeEQ the ideal choice for boorrowers. Get started on your HELOC application today!