The decision between an HEA and a HELOC comes down to your financial situation and future goals.
A home equity agreement (HEA) and home equity line of credit (HELOC) are financial products that allow homeowners to exchange a percentage of their home’s equity for capital. But which one is the better choice for homeowners?
In our HEA vs. HELOC comparison, we compare these two loan types and explain which one is better for certain property owners. Depending on your financial situation and goals, you may want to choose one over the other.
- What is a Home Equity Agreement (HEA)?
- Pros
- Cons
- See All 12 Items
What is a Home Equity Agreement (HEA)?
A home equity agreement, commonly called an HEA, is a contractual agreement between an investor and a homeowner where the homeowner receives a lump sum of cash in return for giving up a portion of the equity in the home and future appreciation on it.
A typical HEA usually has a finite term of 10 to 20 years. However, this is not a contract to be taken lightly, as the homeowner may be giving up a lot of future wealth for some immediate cash today. Homeowners should consider all of the ramifications of a HEA before acting.
When a homeowner contacts an investor or specialty lender, the lender sends out an appraiser to evaluate the home. Upon completion, the lender makes the homeowner an offer on the amount it will pay for a certain portion of the home’s equity. If the homeowner approves the terms, the lender completes the deal and the homeowner pays the closing costs.
The lender then pays the owner a lump sum and places a lien on the home for the agreed-upon amount. When the agreement expires or if the home sells, whichever comes first, the homeowner pays back the lender’s original principal, plus a portion of any appreciation on the updated home value.
The good news is you don’t have to make any payments, not even on the interest, until that point. “This can be particularly advantageous for self-employed individuals or those with variable income who want to avoid additional monthly obligations,” says Reed Letson, owner of Elevation Mortgage.
Homeowners must maintain the value of their property by making repairs, paying their property taxes, and purchasing homeowners insurance.
If the home's value decreases over time, the amount repaid will also decrease because the total given to the lender is based on the home's value at the end of the term. If the home is not sold, the homeowner will still have to repay the original principal plus a percentage of the appreciation within that time frame.
Pros
- No monthly payments are required
- A lower credit score may not be a factor
- There is no interest paid on the principal
- Few restrictions on how the money can be used
- Many HEAs do not include an early payment penalty
Cons
- May require more home equity than the homeowner wants to give
- The principal has to be repaid at some point or when the home is sold
- A large amount of appreciation could be lost
- The lender puts a lien on the home
- It’s not available in every state
What is a HELOC?
A home equity line of credit, or HELOC, is a revolving open credit line based on the equity in your home. You can borrow from it anytime, but your available credit amount decreases as you do.
When you first draw money from the line, you pay interest on that amount, but as you pay down the balance, the interest paid will decline.
A HELOC has a variable interest rate based on the prime rate, typically 3% higher than the Federal funds rate. Therefore, in a rising interest rate environment, your monthly payments could fluctuate, so be sure to ask your lender if they offer fixed-rate HELOCs.
One of the main benefits is that you can use HELOCs for almost anything without question. Most homeowners use it for large expenses such as home remodeling or costly repairs that can increase the home’s value, thereby increasing your home equity.
“HELOCs are particularly useful for ongoing projects or expenses because you only pay interest on what you actually borrow,” Letson says. “The interest rates are usually lower than credit cards, and the interest may be tax-deductible.”
Other people use HELOCs to consolidate debts such as credit cards with higher interest rates.
The HELOC is similar to a credit card in that you can withdraw money from it so long as you don’t hit your borrowing limit and then pay it back with interest until the outstanding amount is zero.
HELOCs generally have a fixed time frame when homeowners can borrow from their home equity, known as the draw period. A draw period typically lasts 10 years, followed by the repayment period, or the time you must repay the principal balance plus interest.
Pros
- Appraisals are not always required. If one is needed, there’s usually no fee.
- There are very few closing costs.
- Once the line is set up, you should have instant access to cash.
- There are no interest payments on any money you don’t use.
Cons
- The HELOC uses your home as the collateral for the money you borrow.
- You have to pay interest on the cash you borrow at a variable rate that can rise.
- You may be required to make at least one withdrawal within the first 30 to 90 days.
- Some HELOCs have an annual fee, whether you use it or not, so ask the HELOC lender in advance if there are any fees.
HEA vs HELOC
| Home Equity Agreement (HEA) | Home equity line of credit (HELOC) | |
| Funding | Lump sum payment | Revolving line of credit |
| Repayment terms | Must repay principal loan after agreed-upon term or when the house is sold. | 10-year draw period (you must make minimal payments on any withdrawn money), followed by a repayment period. |
| Interest rate | None | Variable (some lenders offer fixed-rate HELOCs) |
| Borrowing limit | 80% of your home’s equity | 80% of your home’s equity |
How to Choose Between a HEA and HELOC
Your personal needs and history will determine which financial product is best. According to Letson, it can also depend on how long you plan on staying in the house.
“In my 20 years of mortgage experience, I've found that HELOCs are generally more appropriate for homeowners planning to stay in their home long-term, while HEAs can be a smart choice for those looking at a 5-10 year horizon who want to maintain financial flexibility,” he says.
Suppose you have substantial home equity or believe your home will appreciate substantially over the next 10 years. In that case, you’re better off with a HELOC because you could lose a large chunk of equity or appreciation with a HEA.
On the other hand, if your credit history is not great or your debt-to-income (DTI) ratio is high, the HEA might be a better product. It might also be a better alternative if interest rates are high and trending higher.
Key Takeaways
- HEAs and HELOCs allow homeowners to exchange equity for capital
- A HEA provides you with a lump sum payment, but you’re giving up equity in the house
- HELOCs are revolving lines of credit that you can withdraw from as needed
- An HEA doesn't have to be repaid until the loan term expires or the house is sold
- You’ll have to make minimum payments on HELOC withdrawals during the draw period and repay the rest during the repayment period
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Reed Letson, owner of Elevation Mortgage, a mortgage lender in Colorado and Florida.
FAQ
What are the cons of an HEA loan?
The biggest con of a HEA loan is that you’re giving up equity in your house, which might cause you to lose out on future appreciation. The lender also places a lien on the property.
What is HEA vs HELOC?
A home equity agreement (HEA) and home equity line of credit (HELOC) are both financial products that allow homeowners to tap into their home’s equity for liquid capital. An HEA provides homeowners with a lump sum payment in exchange for a percentage of the home’s equity, whereas a HELOC is a revolving line of credit that they can withdraw from as needed.
What does HEA mean?
HEA stands for home equity agreement, a financial product in which a lender pays for a portion of a home’s equity and provides the homeowner with a lump sum of cash.
Sources
- Reed Letson, owner of Elevation Mortgage
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.