HEA vs. HELOC: Which Is Better for You?

Tailoring home equity to your needs

Why are we mounting an HEA vs. HELOC contest? Because those are two ways in which homeowners can access money relatively quickly by tapping their equity.

If they have a stellar credit score, they can perhaps get a personal loan at a competitive interest rate similarly fast, something that non-homeowners can do, too. But a fair or even good score would likely mean a higher rate than a loan that is secured on a home.

They might prefer to get a home equity loan, which typically has fixed installment payments and is therefore highly predictable. Finally, those over 62 years may wish to explore reverse mortgages.

But when deciding how to leverage their home equity, many will opt for either a home equity agreement (HEA, aka “shared equity agreement”) or a home equity line of credit (HELOC), depending on their personal circumstances.

In this article (Skip to...)

• HEA vs. HELOC: What are they?
• Pros and cons of HEA vs. HELOC
• How to obtain a HELOC
• Which option is right for me?
• The bottom line

What is equity?

Both HEAs and HELOCs require you to tap your equity. But what is home equity? It’s the difference between your current mortgage balance and the fair market value of your home at the moment.

So, suppose your home is currently worth $500,000 and your mortgage balance this morning is $350,000. Your equity is $150,000 ($500,000 value - $350,000 mortgage balance = $150,000 equity).

But it’s rare for you to be able to tap all your equity. For example, most HELOC lenders allow you to access 75%-90% of it, partly depending on the state of your personal finances. It’s harder to get a feel for the proportion of your equity an HEA investor will want you to retain because it’s a smaller, less regulated market.

HEA vs. HELOC: What are they?

HEAs and HELOCs are very different from each other. So, let’s look at them in more detail.

HELOC

A HELOC is a second mortgage that provides you with a line of credit. So, it’s a bit like a credit card in that you can borrow up to your credit limit and you pay interest only on your balance each month. Also, you can borrow, repay and borrow again as often as you want.

But there are important differences between a HELOC and a credit card. Eventually, after a lengthy period that you choose upfront, your borrowing facility will end and you go into repayment mode. You then have another set period (often a decade or longer) during which you must zero your balance. Alternatively, you may refinance your HELOC at this point.

Importantly, a HELOC is secured on your home. And, if you fall seriously behind with payments, you could face foreclosure.

HEA

A home equity agreement isn’t a loan. So, you’re not borrowing a cent and there are no monthly payments.

And that means people are less interested in your credit score and the general state of your finances. Still, sometimes, an investment company may take a peek at your score just to make sure it’s not too subprime: below 500, say.

So, if it’s not a loan what is an HEA? Well, you sell a proportion of your equity to an investor in exchange for a lump sum.

As your home’s value increases and your remaining equity builds, the investor’s share of the home’s equity rises, too, in direct proportion. So, when you come to sell, the investor takes from the proceeds its initial investment plus its share of your property’s higher value.

If your home’s value falls over the period, the investor gets back the amount it paid minus its share of the reduced equity.

Most HEAs last 10-30 years. And, at the end of the period, you could likely buy out the investor by paying back the original sum plus its share of equity appreciation.

You might wonder how many homeowners have access to that sort of cash. Those that don’t would have to sell their home to settle up.

Although most HEAs are originated by investment companies, anyone can do so. Sometimes, parents find them a good way to help out their adult children.

Pros and cons of HEAs vs. HELOCs

Pros and cons of HELOCs

Here are the main pros of HELOCs:

• Unusually flexible: Borrow, repay and borrow again as often as you wish
• You pay interest only on that month’s balance
• Often come with a low interest rate compared to unsecured borrowing
• Some lenders charge zero closing costs
• Cash is usually available quickly, maybe two or three weeks after your application
• Relatively mainstream, safe, regulated, transparent market with few predatory lenders

And here are HELOC’s main cons:

• It’s a loan and you have to pay interest on balances
• After a “draw period” (typically 10 years), you can’t borrow any more
• You then enter a “repayment period” (typically 10-20 years) during which you must zero your balance — unless you can then refinance your HELOC
• A few HELOCs come with balloon payments at the end of the draw period. That means you owe all the money at once. It’s better to avoid these unless you’re confident you’ll have the necessary funds when the time comes
• Your line of credit is secured on your home. And you risk foreclosure if you fall too far behind on payments

Pros and cons of HEAs

Here are the main pros of an HEA:

• No monthly payments
• No interest building up
• Quick access to cash
• Uberlow credit thresholds, if any
• Often no income requirements
• Any-purpose lump sum — Use your money for anything you want

And here are HEA’s main cons:

• Your investor will take a large sum when you sell, including a chunk of “your” equity
• This is a largely unregulated market with limited transparency so only go with reputable companies
• Most benefit from getting professional help to understand the agreement and avoid pitfalls
• Many of these agreements come with eye-watering fees and costs

We reckon HELOCs are the better choice for most homeowners. But an HEA may suit those whose credit or income means they can’t get a HELOC.

How to obtain a HELOC

Applying for a HELOC is a lot like applying for a normal mortgage. But most mortgage lenders turn around applications much more quickly. You may be able to get your hands on the money in only two or three weeks.

As with all significant borrowing, you should shop around several lenders to make sure you get the best deal possible. Federal regulator the Consumer Financial Protection Bureau publishes a downloadable booklet that covers the whole HELOC process.

It provides a comparison chart for quotes from three lenders but you may benefit from getting more. The more frogs you kiss, the better the chance you’ll find your lending prince or princess.

When you get your quotes, compare them carefully. Some mortgage lenders charge zero closing costs, which can be great. But do they charge a higher interest rate? If so, ask yourself which type of deal suits you better.

Documentation and eligibility requirements for obtaining a HELOC

Before lending to you, a mortgage lender will want to confirm your identity, check your credit score and report, and ensure you can comfortably afford the monthly payments. And they need a lot of supporting paperwork to achieve those goals.

So, prepare a bundle of documents before you make an application. These should include a government-issued photo ID and proof of your current and recent addresses going back two or three years.

In addition, you’ll likely need your latest:

• Pay stubs
• IRS returns
• Statements from your bank, broker and anyone else who manages your assets
• Statements showing your existing debts
• Employer’s details to check your employment status

If you’re your own boss, read How to Get a Mortgage When You’re Self-Employed. Some requirements are different for you.

HEA vs. HELOC: Which is right for me?

This is usually the time when we suggest you weigh each option against your personal financial goals and needs, interest rate preferences, and risk tolerance. But that may not be appropriate in our HEA vs. HELOC contest.

On the whole, we reckon anyone who can qualify for a HELOC will likely prefer one. These tend to be less risky and more transparent and predictable. And there’s a good chance that their total cost of borrowing, after interest and any fees and costs, will be lower than the amount an HEA investor will levy by the time it cashes in its investment.

Of course, that’s not to say everyone should opt for a HELOC. Many may be shut out from applying for one by their credit score. And, if you’ve hit hard times, you may not be able to afford even the relatively modest costs of maintaining a HELOC.

Then, choosing an HEA is a perfectly legitimate decision. Just take great care when selecting an investor and reading through the agreement. It’s likely best if you take professional advice from a financial advisor, attorney or accountant.

The bottom line

For most homeowners, there’s a clear winner in our HEA vs. HELOC contest. HELOCs tend to carry less risk and end up less costly over the period of the loan.

However, some can’t get approved for HELOCs. And they may not be able to afford one. For those, HEAs are not only the winner but the only contender.

Still, those applying for an HEA should exercise extreme caution. Most investors are probably honorable. But all largely unregulated markets attract their share of predators.