HEA vs. HELOC: Which is right for you?

Your home can provide much more than just a roof over your head. It can also act as a shelter for your finances, allowing you to borrow against the equity you’ve been building in order to buy new real estate, finance home improvement projects, pay off credit cards, and more. 

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Today, there are more ways than ever to borrow against your home equity. Home equity lines of credit (HELOCs) are one of the most popular options, but they’re not always the right tool for the job. Depending on your needs, a home equity agreement (HEA) might be a better option. 

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Many homeowners are not familiar with the differences between a HELOC vs. HEA, so we’ll compare these two products to help you make a more confident decision for your household.

How does a HELOC work?

A HELOC — as the name implies — operates as a line of credit. You’re free to borrow money as you need up to your credit limit, making it perfect if you’re looking for a flexible source of funds. If you’re a weekend warrior who’s always tinkering with projects around the house, a HELOC could be a perfect way to get the materials you need without having to shelve your project while you wait for more funding. 

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A HELOC is generally split up into two phases. You’re able to borrow money during the draw phase, which typically lasts five to 10 years. During this time, you’ll only have to make interest-only payments, so your monthly bill will be a lot lower. (You can still pay off the debt, however, to save money and refresh your credit limit.) 

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After that, the HELOC goes into a 10 to 20-year repayment phase, when your payments will increase to repay the debt. You won’t be able to borrow any more during this period, although your monthly payments may still change over time because HELOCs generally charge variable interest rates. 

HELOC pros and cons

Pros

• Flexible funding
• Can help build credit
• Available from many lenders
• Interest-only payments to start

Cons

• Ongoing fees
• Variable interest rate
• Not assumable by heirs
• Fluctuating monthly payments
• Increases debt-to-income ratio
• Steeper credit and income requirements
• Temptation to borrow more than you require
• Credit limit may be reduced or frozen if equity declines

How does an HEA work?

A home equity agreement, in contrast, offers a lump sum more akin to a personal loan. It’s not a debt, however; it’s an investment. 

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Rather than paying a steady amount of interest over time, you’ll pay for the funding as a percentage of your home equity at a later date, typically 10 to 30 years. However, you can repay it whenever you like. Just like the name implies here as well, it’s an investment that someone’s making in your home, with the hopes that your home’s future value will increase. 

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This leads to one of the biggest benefits of an HEA: you won’t need to make any monthly payments until the final payment is due. That frees up your monthly cash flow, allowing you to handle day-to-day expenses better. Typically, most HEAs are repaid by selling your home, with savings, or by taking out another type of debt when you’re better able to qualify for financing. 

HEA pros and cons

Pros

• No ongoing fees
• No monthly payments
• Long repayment horizon
• One-and-done lump sum
• Doesn’t increase debt-to-income ratio
• Heirs can assume contract to keep home

Cons

• Doesn’t help build credit
• Intricate funding contract
• Limited choice of financing partners
• Need to plan for large lump-sum payment

HELOC vs. HEA: key differences

There are many similarities between HEAs and HELOCs, such as unknown long-term financing costs and having your home appraised to ensure you have enough equity available. You’ll find many differences between the two products, however, which are important to consider in relation to your situation:

• Fees: Both products charge an origination fee and other closing costs. A HELOC often comes with ongoing fees, however, such as annual fees or draw fees each time you tap into your line of credit. 
• Credit score: You’ll generally need a higher credit score to get a HELOC, often around 620. Most HEA providers, on the other hand, require a credit score of just 500 to qualify.
• Funding type: A HELOC allows flexibility to borrow the exact amount you need, when you need it. An HEA, on the other hand, will give you a larger lump sum up front, but you won’t be able to borrow more unless you submit a separate application for funding. 
• Impact on heirs: When you take out a HELOC, your heirs will need to pay it off before they can inherit your home. If you pass away with an HEA in place, however, they may be able to assume the agreement and take over right where you left off in the contract.
• Credit reporting: Lenders report HELOC payments to the credit bureaus, which can help you build credit as long as you make on-time payments. An HEA is not a debt, however, so it won’t help you build credit — but it won’t hurt your credit, either. 
• Payoff procedure: A HELOC is repaid with steady monthly payments during the repayment phase. An HEA is repaid in one single lump sum at the end of its term length by selling your home or repaying it with some other method. 
• Monthly payments: Borrowing against your HELOC means cutting into your monthly cash flow and increasing your debt-to-income (DTI) ratio because you’ll need to make monthly payments. An HEA, in contrast, requires no monthly payments and thus has no impact on your DTI ratio. 
• HELOC recall: If home values drop enough, you can lose your home equity line of credit (HELOC) because you may no longer have sufficient equity. That won’t happen with an HEA, however, since once the funds are disbursed, they can’t be recalled.
• Funding source options: Most public banks and credit unions around the country offer HELOCs. Only a few companies offer HEAs, however. Some companies, such as Point, refer to them by a different name: home equity investments, or HEIs. 

How to determine what’s best for you

First, it’s crucial to determine whether tapping into your home equity is right for you or not. In some cases, an unsecured debt like a personal loan or a credit card might work better. Most finance experts recommend using home equity financing for things that increase your home’s value rather than for other uses, like your child’s education or a vacation. 

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That’s because all home equity financing carries a big risk: if you don’t pay it back, your lender may be able to foreclose on your home to pay back the debt. No one wants that, lenders included. In addition, you’ll typically need at least 20% equity in your home to meet the requirements for HELOCs and other funding options, and not everyone has that yet. 

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If you’re able to meet the home equity financing requirements and tolerate the risks, here’s how you can tell which might work better for you: a home equity agreement vs. a HELOC.

When a HELOC is a good idea

Here are some signs that point toward a HELOC being a better option vs. an HEA:

• You want to use the HELOC to help build credit.
• You want the freedom to borrow money as needed.
• You’re not concerned about leaving your home to any heirs.
• You have regular income to make ever-changing monthly payments.
• You want peace of mind that you have access to quick funding at any time.
• You want to borrow from a bank, credit union, or other lender you already know.
• You don’t want to make one large lump-sum payment a decade or more down the road.

When an HEA is a good idea

Take a look at these statements and see how many resonate with you compared to the above list. If these sound more appealing to you, then you might have more success with an HEA vs. a HELOC:

• You don’t want to make any monthly payments.
• You want to give your heirs an easier path to inherit your home.
• You have a specific large purchase in mind for which you need funding.
• Your credit score and income aren’t high enough to qualify for a HELOC.
• You don’t want the easy temptation to borrow more money than you might need. 
• You’re planning on bequeathing or selling your home within the next 10 to 30 years.

Alternatives to HEAs and HELOCs

Home equity agreements work for many homeowners, but not all. The same is true for home equity lines of credit. Before you decide on a HEA vs. a HELOC, make sure you consider the pros and cons of other types of loans, too, including:

• Home equity loan
• Reverse mortgage
• Cash-out refinance loan

If an HEA, reverse mortgage, or cash-out refinance doesn’t sound right for you, then you’ll need to decide between a HELOC vs. a home equity loan. This is the common choice that most homeowners face, in fact, and the answer mostly boils down to whether you want access to a lump sum of cash or a line of credit to use at will. 

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Home equity loans are paid out in one single funding event, with fixed-rate payments that let you know in advance exactly how much you’ll need to pay each month. Home equity lines of credit, on the other hand, are more nimble in responding to your funding needs but add more variability to your monthly budget, too. 

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Final thoughts

Choosing between an HEA vs. HELOC can be a tough decision, and it’s always a good call to talk to a financial advisor if you can. If you’re facing financial problems, a reputable credit counselor with the National Foundation for Credit Counseling may also be able to provide free and unbiased advice. 

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Many people prefer HEAs over HELOCs due to the ease of qualifying and the lack of monthly payments, but make sure you have a plan in advance for how you’ll repay the financing. Otherwise, a HELOC might be a better fit. It’s always free to check your options, however, which you can do by getting prequalified for a HELOC or an HEA.