How to pay back your HEI: HELOC or home equity loan

An HEI can be a gateway to many things, whether you use it to improve your current home, buy a second home near family, or even free yourself from expensive credit card debt. An HEI is different than a traditional loan and doesn't require monthly payments, which is one of its big advantages. However, when you're ready to pay back your HEI, you can use several financing options to pay Point back. We'll help you figure out if a home equity loan or HELOC is in your best interest when you're ready to part ways with your current HEI or if another option would be better. 

HELOCs and home equity loans: An overview

Home equity loans and HELOCs are similar to HEIs in that they both rely on home equity, but that’s where the similarities end. 

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Home equity loans and HELOCs are both debt products, which means you’ll need to meet stricter qualification requirements. In addition to having a good credit score and income, most lenders only allow you to borrow up to 80% of the equity in your home, minus the balance of your mortgage. 

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You’ll also need to make monthly payments with a home equity loan or a HELOC, and this is where the two start to differ from each other. Home equity loans are given out in a single lump sum and repaid as a fixed-rate interest rate loan, meaning your payments stay the same each month. 

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HELOCs, on the other hand, allow you to borrow money — up to a predefined credit limit — during a draw period, often lasting 10 years. You’ll make interest-only payments during this time, with the option to pay back any amount you’ve borrowed. After the draw period is over, the repayment phase begins, often with a 10-20 year term. HELOCs come with variable interest rates, which means your payment amount can change over time. 

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Point can work with home equity loan and HELOC lenders to help you pay off your HEI.

Pros and cons of using a HELOC or home equity loan to pay back your HEI

Home equity loans and HELOCs are closely related but they work a bit differently from each other, and that can make a big impact on your finances. We’ll cover the pros and cons of each one separately:

Pros of HELOCs

• Build credit: If you make all of your payments on time a HELOC can help you establish a strong payment history, which is a major factor for your credit score. 
• Stay in your home: You don’t need to sell your home to pay back your HEI, and you can fully retain any future appreciation in your home’s value. 
• Access flexible funds: You can draw against your HELOC to fully pay back your HEI if you’re approved for a high enough credit limit. You may be able to draw funds as needed later, too, especially if you pay down your balance during the draw period.
• Smaller initial payments: It’s easier to manage smaller interest-only payments during the draw phase of your HELOC.
• Deduct HELOC interest on taxes: Interest paid on a HELOC may be tax-deductible, but we recommend checking with your accountant to be sure.

Cons of HELOCs

• Increase in debt: You’ll be required to make monthly payments which can be substantial, especially during the repayment phase. That can make it tougher to qualify for other financing and can put a strain on your monthly budget.
• Fees: Like other loan types, HELOCs come with closing costs and fees – often 2-5% of the total loan amount.
• Tougher qualification: You’ll typically need at least 20% equity in your home, as well as a good credit score and a strong and consistent source of income.
• Danger of losing home: As with other secured products, if you default on the new debt, your lender can foreclose on your home and sell it to pay off what you owe. 
• Fluctuating monthly payments: It’s harder to budget for HELOC payments because they come with variable interest rates. In addition, you may be making interest-only payments or full payments at any given time, depending on which phase you’re in.

Pros of home equity loans

• Credit building: Home equity loans can also help you establish a strong credit score if you don’t miss any payments. 
• Home retention: You also have the option to stay in your home and keep your full equity amount, should you ever sell, once your home equity loan and mortgage are paid off. 
• Tax-deductible interest: You may be able to deduct the interest you pay for a home equity loan on your tax return, but it’s good to verify this with your tax professional first. 
• Lump-sum disbursement: You can pay off your HEI with one single loan, rather than taking out a line of credit that may be tempting to borrow against in the future. 
• Steady, predictable payments: It’s easier to fit home equity loan payments into your budget because once you take the loan out, your payments won’t change. 

Cons of home equity loans

• More debt: Taking out a home equity loan now can impact your ability to pay your bills on time, and affect your ability to finance other purchases too.
• Strict qualifications: You’ll generally need to have good income and credit, as well as at least 20% equity in your home.  
• Closing costs: Home equity loans may come with expensive loan fees as well, similar to HELOCs. 
• Possibility of losing home if you default: As with a HELOC or another type of secured product, if you can’t repay the loan, your lender may sell your home to pay off the debt you owe. 
• Higher rates: You'll most likely pay a premium for the security of a fixed-rate loan.

Is a HELOC or home equity loan the best way to pay back your HEI?

Debt products like home equity loans and HELOCs can help you pay back your HEI, but it’s especially important to ask yourself a few questions before you settle on this route. 

Are you able to qualify for financing?

It can be difficult or impossible to get approved for a HELOC or home equity loan at an affordable rate if you don’t have good credit. If you weren’t able to qualify for a good financing offer before, you may be able to now — especially if you’ve paid off higher-interest debt and practiced good debt management habits in the meantime, like making your payments on time each month.

Can you afford to make monthly payments?

Not having to make monthly payments is a big draw of HEIs for many people, especially if you’re on a fixed income. Potential lenders want to see that you have a steady source of income, especially compared to any debt payments you may be making. It’s a good idea to check your budget and see how much you would be able to afford for a monthly payment, making sure to leave plenty of wiggle room.

Do you want to stay in your home?

Selling a home is another popular way many homeowners pay back their HEI. That’s a great option if you’re already looking to change abodes, but if it’s not, a home equity loan or HEI can be one of the tools you can use to satisfy your agreement with Point and stay put. 

Do you want an open line to borrow money?

A HELOC can be a particularly valuable tool for retaining financial flexibility. You may be able to pay down your balance during the draw period, opening an opportunity for you to borrow money again as needed. 

Do you want to replace your entire mortgage?

Home equity loans and HELOCs are closely related to another financing option: a cash-out refinance, which allows you to replace your current mortgage with a larger one, using the extra proceeds to pay off your HEI. It’s a good option in some cases, but a HELOC or home equity loan allows you to keep those debts separate if, for example, you already have a great rate on your mortgage.