HELOC vs. Home Equity Loan for Michigan Homeowners

What is a HELOC and how does it work?

A Home Equity Line of Credit (HELOC) enables homeowners to borrow money from the equity they own in their own homes. When you apply you are given a borrowing limit and within the initial draw period, usually about 10 years, you can borrow freely up to that limit while only paying interest. Then you enter the repayment period, typically 20 years, during which you repay the principal and interest.

HELOC requirements

Owning a home doesn’t automatically make you eligible for a HELOC. Typically you will need to own at least 15-20% of the equity in your home. You can calculate that by dividing your current mortgage balance by the appraised value of your home. Your credit score is also very important. Scores as low as 620 may be accepted but scores at 680 and above are generally preferred and will bring better loan terms. For example, most lenders also require your Debt-to-Income (DTI) ratio to be below around 43% depending on your credit score.

To make the math easy, online calculators like this one can help you determine how much of your equity you can unlock.

Advantages of a HELOC

Because a HELOC is based on the value of a stable asset like a home, it brings great flexible and favorable terms for borrowers. Here are some of the key advantages of a home equity line of credit you should be aware of:

• Borrow only what is needed rather than the full credit line at once
• Pay interest solely on the amount drawn, not the total limit
• Funds become available again as you repay the balance
• Some lenders allow locking in a fixed rate on part of the balance

Disadvantages of a HELOC

Even with all its advantages, there are also important disadvantages of a home equity loan you absolutely need to consider before borrowing. Here are the most important to consider:

• Variable rate means payments can increase over time
• Risk of over-borrowing during the draw period if only interest is paid
• Lenders can reduce or freeze the credit line if home values decline
• Home serves as collateral, carrying foreclosure risk

What is home equity?

Home equity is the part of your home that you actually own. For example, if your home is valued at $500,000 and you owe $200,000 on your mortgage then you have $300,000 in home equity. Because it’s based on the value of your home, market appreciation and home improvements can increase your equity.

What is a home equity loan and how does it work?

A home equity loan lets Michigan homeowners borrow a lump sum against the equity they own in their home. That sum is then paid back via fixed monthly payments over the course of 5-30 years.

Home equity loan requirements

If you’re comparing a HELOC vs home equity loan you’ll find the requirements are very similar. You’ll typically need to own at least 15-20% of the equity in your home, have a credit score of at least 620, and a DTI of 43% or lower to qualify for a home equity loan. Bear in mind these requirements can vary from lender to lender and better credit scores will get you better loan terms. Want to walk through it? Schedule an appointment to chat with an orsa mortgage team member by phone, video chat, or at a branch!

Advantages of a home equity loan

Home equity loan advantages include things like predictable payments and access to larger initial funds. Here are the four main ones to be aware of:

• Fixed payments make budgeting predictable
• Access to a larger lump sum than other loan types like personal loans
• Funds can be used for any purpose, not earmarked like some other loans
• Interest may be tax deductible when funds go toward home improvement

Disadvantages of a home equity loan

If you’re comparing a HELOC vs home equity loan you’ll also want to familiarize yourself with the disadvantages of a home equity loan. Here are the most important ones:

• Home serves as collateral, carrying foreclosure risk
• Owing more than the home is worth if property values decline
• Closing costs typically range from 2% to 5% of the loan amount
• Approval can take longer due to the appraisal and underwriting process

What’s the difference between a HELOC and home equity loan?

In most cases, Michigan homeowners thinking about a HELOC will also look at a home equity loan. To help you understand which might be right for you, here is a comparison chart to see the differences of HELOC vs home equity loans.

Which is better for you?

An easy way to think about HELOC vs home equity loans is around when you get flexibility and when you get predictability. A HELOC gives you flexibility up front, as you can borrow as much as you like whenever you like during the draw period. However, once you begin to repay it, variable interest rates mean those payments can change over time.

With home equity loans you get more predictability but less flexibility. You borrow a single lump sum, but your interest rate is fixed so you know exactly how much you’ll pay for the duration of the loan.

Explore your home equity options with orsa

Overall, Michigan homeowners interested in using their home equity to finance things like home improvements have solid options to choose from. Whether that’s a more flexible HELOC or a structured and home equity loan, our financial experts will help you understand your options and how to decide which one works best for you.

Of course, you first need to be a member, so if you aren’t already just apply here and join orsa, a for-impact credit union built by Michiganders for Michiganders.