Conventional Loan vs HELOC: Which Is Better For You?

A conventional loan and a home equity line of credit (HELOC) are two popular options for financing a home purchase or tapping into your home’s equity. But they work very differently, so it’s important to understand the key differences before deciding which is better for your needs.

What is a Conventional Loan?

A conventional loan is a mortgage that conforms to guidelines set by Fannie Mae and Freddie Mac. These government-sponsored enterprises buy loans from lenders and sell them to investors on the secondary mortgage market.

To qualify for a conventional loan, you’ll typically need:

• A credit score of at least 620-640
• A debt-to-income ratio below 45%
• A down payment of at least 3-20% of the home’s value

Conventional loans come with lower interest rates than FHA or VA loans. And you avoid having to pay mortgage insurance if you make a 20% down payment.

Pros of conventional loans:

• Lower interest rates than government loans
• No mortgage insurance with 20% down
• Easier to qualify than FHA, USDA, or VA loans

Cons of conventional loans

• Require higher credit scores
• Need larger down payments than government loans
• Mortgage insurance required with less than 20% down

What is a HELOC?

HELOC stands for home equity line of credit. It uses the equity in your home as collateral allowing you to borrow against the value you’ve built up.

With a HELOC, you have a revolving line of credit where you can withdraw money as needed, up to a set limit. It works similarly to a credit card.

During the draw period, you can access the funds then repay on your own schedule. The repayment period kicks in once the draw period ends, requiring you to pay back the full balance.

HELOCs have variable interest rates, meaning your rate can go up or down over the life of the loan. They also use your home as collateral, so failing to repay it could put your home at risk of foreclosure.

Pros of HELOCs:

• Access to a revolving credit line
• Only pay interest on what you use
• Variable rates can go down over time
• Often easier to qualify than home equity loan

Cons of HELOCs:

• Rates and payments can increase over time
• Risk losing home if payments are missed
• Usually cost more than home equity loans
• Can only borrow up to 85% of home’s value

Key Differences Between Conventional Loans and HELOCs

Here are some of the main ways conventional mortgages and HELOCs differ:

Down Payment Requirements

Conventional loans require a down payment of at least 3-20% of the home’s purchase price. With a HELOC, you don’t make a down payment since you already own the home.

Purpose

Conventional loans are for buying a home. HELOCs allow homeowners to tap into home equity for other uses like home improvements, debt consolidation, college tuition, etc.

Loan Amount

Conventional mortgages provide enough money to buy the entire home. HELOCs let you borrow up to 85% of your home equity.

Repayment

Conventional loans have fixed monthly principal and interest payments. HELOC payments vary based on usage. The draw period has interest-only or minimum payments.

Interest Rates

Conventional loans have fixed rates that don’t change. HELOCs have adjustable rates that can go up or down over time.

Home Ownership Requirement

You don’t have to own a home to get a conventional mortgage. HELOCs require you to be a homeowner with equity already built up.

Risks

Not repaying a conventional loan could lead to foreclosure. The same risk applies if you default on a HELOC.

When Is a Conventional Loan Better Than a HELOC?

There are a few key scenarios where a conventional mortgage tends to be the better financing option compared to a HELOC:

Buying Your First Home – HELOCs require you to already own your home, so they aren’t an option for first-time homebuyers. Conventional loans allow borrowers to finance up to 97% of the purchase price.

Need a Large, Fixed Amount – Conventional loans provide lump sum financing that you’re certain you can afford. HELOCs have adjustable limits that may fall short of your needs.

Prioritizing Low, Fixed Payments – Conventional loans lock in your principal and interest payment for the full term. HELOC payments can vary a lot from month to month.

Strong Credit Profile – Conventional loans reward higher credit scores with lower interest rates. HELOCs don’t offer huge rate discounts for great credit.

Plan to Move Soon – HELOC repayment periods often extend 10-20 years. Conventional loans may better match a shorter expected timeframe in the home.

When Might a HELOC Be Preferable to a Conventional Mortgage?

In other situations, a HELOC could prove to be the more advantageous financing choice over a conventional home loan:

Already a Homeowner – HELOCs require you to have existing home equity, so they work better for borrowers who currently own.

Unsure of Loan Amount Needed – A HELOC provides flexible access to funds as needed, while conventional loans provide a fixed lump sum.

Using for Shorter-Term Goals – HELOCs allow you to borrow just what you need in the near term, rather than taking on one big 30-year conventional loan.

Want to Consolidate Higher-Rate Debt – An affordable HELOC can help lower the cost of existing credit card, auto loan, or student loan balances.

Need Access to Emergency Funds – HELOCs give homeowners a source of funds to tap if unexpected expenses come up.

Which Option Is Right for You?

When deciding between a conventional mortgage and HELOC, consider your specific situation:

• Are you looking to purchase a home or tap equity in a home you already own?
• Do you need a set loan amount upfront or flexible access to funds?
• How long do you plan on staying in the home?
• What is your credit score and income?
• Do you qualify for low conventional mortgage rates based on your credit profile?

Carefully comparing costs and weighing the pros and cons can help determine if a conventional loan or HELOC better fits your needs. Be sure to get rate quotes from multiple lenders as you assess both options.

Alternatives to Consider

Beyond conventional loans and HELOCs, a few other products can help finance a home purchase or tap home equity:

FHA Loan – Government-backed mortgages with low down payment and credit requirements. Come with upfront and annual mortgage insurance premiums.

Cash-Out Refinance – Replace your current mortgage with a new, larger loan to access equity. Results in higher payments and costs than a HELOC.

Home Equity Loan – Lump sum second mortgage with fixed rate and term. No access to additional funds after closing.

Reverse Mortgage – Allows seniors 62+ to access equity through monthly payments or lump sum. Loan must be repaid when they move out or die.

Personal Loan – Unsecured loan that doesn’t use your home as collateral. Shorter terms and potentially higher rates than home equity options.

Key Takeaways

• Conventional loans help buyers finance the purchase of a home, while HELOCs allow homeowners to borrow against existing home equity.

• Conventional loans have fixed rates and payments, while HELOCs have adjustable rates and flexible payments.

• Conventional mortgages involve larger, upfront loan amounts needed to buy a house. HELOC limits are based on your available home equity.

• Conventional loans make sense for first-time buyers, those wanting fixed payments, and people moving soon. HELOCs can work better for shorter-term goals or unpredictable funding needs.

• Shop lenders to compare costs for both options and determine if a conventional mortgage or HELOC better suits your financial situation.