Home equity lines of credit (HELOCs) and home equity loans are useful for paying off other debts. Both options use the equity built in a residence as security, thereby reducing the lender’s risk and helping to minimize overall interest costs.
Members 1st Federal Credit Union, a financial cooperative with over 75 years of experience based in Enola, Pennsylvania, talks about the advantages of taking out a HELOC vs. a home equity loan to show which makes more sense to consolidate debt.
Advantages of Using a HELOC When Consolidating Debt
A HELOC is useful for people who seek flexibility when consolidating debt.
Flexible Cash Access
HELOCs feature a draw phase that enables access to equity, and funds can be withdrawn as needed. This gives individuals control over which obligations to prioritize and when to pay them off.
Lower Monthly Payments
Members 1st explains that lenders permit borrowers to pay just the interest and defer the principal. HELOCs typically carry variable rates, which are lower than fixed rates but fluctuate monthly.
While deferring principal does not reduce the balance, individuals can pay it down or off at any time. Some lenders may charge a percentage of the outstanding balance or a flat fee for early payoff.
According to Members 1st, “[Borrowers] can choose to lock in [their] interest rate and switch from a variable rate to a fixed rate on all or part of what [they] borrow.” Nonvariable rates can make HELOC interest payments stable, predictable and slightly higher.
No Withdrawal Requirement
Not drawing funds does not close the account, and borrowing nothing means no interest charges. An active line enables consolidation of future obligations without seeking new credit.
Advantages of Using a Home Equity Loan When Consolidating Debt
This installment loan offers benefits for those who prefer predictability.
Predictable Interest Rate
Rates on these loans usually remain constant regardless of market conditions, and this predictability can make it easier to estimate potential savings when consolidating higher-interest obligations. A fixed rate makes it easy to identify which costs more.
Stable Monthly Payments
These loans are fully amortized, meaning they are paid off through scheduled payments, and fixed rates keep costs predictable. Extra payments, if allowed, reduce the total interest paid, as they apply directly to the principal.
Clear Repayment Timeline
Installment loans only have a repayment period. This closed-ended option makes it easier to plan finances.
HELOC vs. Home Equity Loan for Debt Consolidation — Which Makes More Sense?
Taking out an installment loan is conventionally more suitable for paying off debts, although HELOCs may make more sense in some situations.
When the amount needed is known, lump-sum financing is ideal, but high closing costs can make it expensive. Revolving credit carries ongoing fees but fewer up-front costs, especially from credit unions.
According to Members 1st, “Since credit unions are not-for-profit, they often have lower fees or may waive certain fees on a HELOC, though specific closing costs can vary.”
Considering all applicable fees helps determine whether a HELOC or a home equity loan makes more financial sense for the situation.
Frequently Asked Questions
These answers address common questions people interested in consolidating debt have about using a HELOC vs. a home equity loan.
Is using a HELOC to consolidate debt better than taking out a home equity loan?
Using a HELOC to consolidate debt is not necessarily better than taking out a home equity loan, and vice versa. The more suitable option depends on the situation. HELOCs offer flexibility and lower minimum payments, while installment loans have clearer repayment timelines with fixed installments.
Do HELOCs have lower interest rates than home equity loans?
HELOCs generally have lower interest rates than home equity loans, though those rates can fluctuate. The interest on lump-sum financing is generally fixed, slightly higher but predictable. Members 1st explains that some lenders allow borrowers to lock in their rate.
Does a HELOC have higher closing costs than a home equity loan?
No, a HELOC usually has lower closing costs than a home equity loan. Many lenders waive certain up-front charges for HELOCs, while installment loans can have closing costs that reach thousands of dollars but rarely include recurring charges.
Use Home Equity Strategically to Consolidate Debt
The advantages of HELOCs vs. home equity loans can overlap, but either option is more beneficial for some borrowers. Evaluating rates, fees and conditional charges like prepayment penalties is key to calculating borrowing costs when consolidating debt.
