Home equity loan or line of credit: What’s the difference?
So, you have a big purchase or other major financial undertaking on the horizon, and you’re looking for the best way to fund said expense. For homeowners, both the home equity line of credit (or HELOC) and the home equity loan are great options, as both use the equity you have in your home to allow you to borrow funds. Chances are, though, that one option works better for your unique situation, as they work differently and have different advantages. In this article, we’ll define each of the terms and walk through their differences and benefits. But first, let’s start with a little refresher on equity.
Using your home’s equity
Home equity lines of credit and home equity loans are both types of loans that allow homeowners to borrow money against the equity they have built up in their homes by using their property as collateral. As a refresher, equity is the difference between the market value of your home and the amount you owe on your mortgage. For example, if your home is valued at $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity. Typically, up to 85% of the value of your home minus your outstanding mortgage balance is available for borrowing. That said, the amount of equity you have in your home, your credit score, and other factors will come into play when determining both the interest rate and the amount available to borrow.
The interest rates on both HELOCs and home equity loans are typically lower than other types of loans because they are secured by your home. Both can be used for a variety of purposes, such as major purchases, home improvements, family vacations, or college tuition.
The line of credit
A HELOC is a revolving line of credit with a variable interest rate. It works like a credit card in that you have a maximum credit limit and have access to funds as you need them, generally by transferring funds into your checking account. You can pay back and withdraw again as many times as needed during the draw period. When the draw period ends, the repayment period begins (if you’re still carrying a balance).
Part of the beauty of a HELOC is that you can borrow only what you need, and pay interest only on the amount you borrow, which is great if only a small amount of money is needed. Additionally, because a HELOC is a revolving line of credit, you can borrow and repay as needed, which can be useful if you have ongoing expenses or are not sure how much you will need to borrow (think: college tuition or ongoing medical bills). Something you’ll want to take into consideration, however, is that a HELOC is a variable rate loan, so your payments could increase if interest rates go up.
A home equity loan is a bit different in that it’s a lump-sum loan with a fixed interest rate. It works like a traditional loan in that you receive the entire amount up front. Repayment is traditional, too, as you’ll have a clear repayment schedule, repaying the loan in equal monthly installments over a set period of time, usually 10 to 30 years.
A great benefit of a home equity loan is that the interest rate is fixed, and your payment amount will be consistent, so you’ll have a clear repayment schedule and can budget accordingly. This makes home equity loans a popular choice for major home renovations and debt consolidations. A structured, lump-sum loan such as this works well if you know exactly what you’ll use the funds for and how much you’ll need since it doesn’t offer the flexibility of a HELOC, where funds availability is concerned.
The choice is yours
In summary, HELOCs and home equity loans are both helpful tools for homeowners looking to leverage their home’s equity. When deciding between the two, consider your specific needs and financial situation. If you need ongoing access to funds and are comfortable with a variable interest rate, a HELOC may be a good option, while a home equity loan may work better if you’re after a lump sum of money and need to budget for your payments. Whatever you choose, there’s no need to make the decision alone — our friendly experts are here to help!
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