HELOCs, Home Equity Loans and Home Equity Agreements ─ What’s the Difference?

Thanks to the rising cost of housing, homeowners have more equity in their real estate than ever – and a lot of that money is just waiting to be tapped for something important, like consolidating debt, managing major expenses or funding renovations.

Since your home is probably the biggest asset you have, it is smart to investigate all the options. Three of the most common ways to access the equity you have been building are home equity lines of credit (HELOCs), home equity loans and home equity agreements (HEAs). 

Each of these options works differently, offers unique benefits and comes with specific considerations. In this blog post, we’ll break down the differences to help you choose the best option for your financial situation.

 

Simply put, home equity represents the portion of your home that you own outright. It’s the difference between your home’s estimated current market value and whatever you still owe on your mortgage. These days, that can be significant. For example, if your home is worth $400,000 and you owe $200,000 on your mortgage, your home equity is $200,000.

Your equity can be borrowed against, but how you choose to do so depends a lot on your specific goals and financial situation. 

 

A Home Equity Line of Credit (HELOC) is a revolving line of credit that is secured by your home’s equity as collateral. Unlike a traditional loan – where you receive a lump sum of money all at once – a HELOC functions similarly to a credit card: you’re given a credit limit, and you can borrow from it at any time during the specified “draw” period (which typically ranges anywhere from five to 10 years). That gives you considerable time to decide how you want to spend your money. Another advantage is that homeowners have a borrowing range if they are unsure how much money they may need.

With a HELOC, you only get charged interest on the amount you borrow, which many homeowners appreciate. Plus, during the draw period, you may only need to make interest payments. After the draw period ends, the repayment period begins (usually 10 to 20 years), during which you must repay both principal and interest. 

What are the drawbacks? Most HELOCs have variable interest rates, which means the rate can fluctuate based on market conditions. While this can result in lower payments when rates are low, it also introduces the risk of higher payments if interest rates rise. Plus, you always run the risk that you’ll overspend or be caught off guard by the combined payment (your initial mortgage and the HELOC) once the draw period ends.

 

A home equity loan allows you to borrow a fixed amount of money – as one lump sum – up to a certain percentage of the equity that you have built. Unlike a HELOC, where you have the flexibility to borrow the money as needed, a home equity loan gives you all the money upfront, with fixed terms for repayment. This is typically what people refer to when they talk about having a “second mortgage.”

Most home equity loans come with fixed interest rates, meaning your monthly payments remain constant throughout the life of the loan. This can be beneficial if you prefer predictable payments and want to avoid the risk of fluctuating interest rates – and it’s good when you know exactly how much money you need for your goals. However, unlike a HELOC, you have to start making payments on the full amount of the loan immediately, and that can be daunting to some homeowners.

 

A Home Equity Agreement (HEA) is a relatively newer option that allows you to access a portion of your home’s equity without taking out a loan. Although growing in popularity, it’s still relatively unfamiliar to a lot of homeowners. Unlike HELOCs and home equity loans, which involve borrowing money and making monthly payments, a HEA involves selling a percentage share of your future home appreciation in exchange for an upfront payment.

Essentially, HEAs are investment opportunities for others. They bet that the equity in your home will continue to rise over time and that they’ll recover their investment – plus some – once your home is sold at some point in the future. You get a lump sum of money upfront, but this isn’t a regular loan, so there’s no additional debt in your name and you don’t need to make monthly payments or pay interest like you would with a loan. 

HEAs can be particularly appealing for homeowners who want to access cash but don’t want to take on new financial liabilities or worry about maintaining repayment schedules. This can make HEAs especially attractive for people on a fixed income or those with troubled credit. 

The only drawback is that you really don’t know how much you’ll have to pay when you eventually sell your home and settle the agreement – since that will depend entirely on how much the value of your home has appreciated or depreciated by that time. Homeowners who expect their property value to appreciate significantly may want to think twice before giving up a portion of that future value.

 

There are numerous things that you may need to consider when you’re thinking about a HELOC, home equity loan or HEA, including:

• Your Financial Needs: If you need a lump sum for a large, immediate expense, a home equity loan might be the best choice. If you need flexible access to funds over time, a HELOC could work better. If you want cash without taking on new debt or monthly payments, an HEA could be the right fit. Since HEAs are also not dependent upon your credit score, they can be useful for people who have had prior financial struggles.
  
  
• The Going Interest Rates: If interest rates are low and you want the security of fixed payments, a home equity loan can be very appealing. If you’re comfortable with variable rates and want the option to borrow only what you need, a HELOC might be more appropriate. If you’re just not sure what to expect, a HEA sidesteps the whole issue.
  
  
• Anticipated Future Home Value: If you expect your home to appreciate significantly, be cautious with HEAs, as you’ll be sharing a portion of that future gain. However, if you’re unsure or expect only modest growth, a HEA can be a great way to unlock home equity without increasing your monthly expenses.

All three options offer distinct advantages – and they all have potential drawbacks. Understanding how these financial arrangements work and how they align with your needs is essential to making an informed decision that supports your fiscal well-being in both the short and long term.