Home Equity Loan vs. Home Equity Line of Credit (HELOC)
There are two ways of borrowing money against the equity in your home;a home equity loan and a home equity line of credit. Both a home equity loan and a home equity line of credit are often called a second mortgage' because they allow you to borrow additional money using your home or real estate as collateral. A home equity loan or home equity line of credit is usually for a shorter period of time than your original mortgage, though, and is often for less than the full value of your home. Generally, a home equity loan or line of credit must be repaid within 15 years or less, though it is possibly to get longer terms.
What are the differences between a home equity loan and a home equity line of credit?
When you take out a home equity loan, you get the money in one lump sum, and pay it off in monthly payments over the course of several years. You can't borrow more money without taking out another loan application. As with any other loan, you pay interest on the balance of the loan each month until it is paid off in full. A home equity loan is a good choice if you have a large expense that must be paid for all at once.
A home equity line of credit, often referred to as a HELOC, is more like a credit card. When you apply for a home equity line of credit, the bank determines a credit limit; the most money they are willing to lend you over the life of the loan. When your home equity line of credit is approved, you'll get either paper checks or a plastic card or both that you'll use to draw against the line of credit that has been established. As you withdraw money, your home equity line of credit is reduced. When you make payments on the principal, the money in your home equity line of credit is there to borrow against again.
For example, suppose you are approved for a $10,000 home equity line of credit. You withdraw $3000 to pay for a vacation cruise the first year. You now owe $3000 on a home equity loan and have $7000 remaining on your home equity line of credit. Instead of borrowing more, you make regular payments and pay back $2000 of the principal. Now you have $9000 that you can borrow against in your home equity line of credit.
If you take out that same amount, $10,000, as a home equity loan, you would get $10,000 in one lump sum. You'll pay it back as a fixed monthly amount that is partly interest and partly payment on the principal. Depending on the terms of the home equity loan, your monthly payments may vary slightly if the interest rate in an adjustable rate mortgage changes, but generally, you can count on paying about the same amount each month.
By contrast, a home equity line of credit is broken down into two periods; the draw period, during which you can withdraw money against the line of credit, and the repayment period, during which you must repay it. During the draw period, the minimum monthly payment on your home equity line of credit is for the interest only. You can choose to pay more than the minimum and have it applied to the principal, but you don't have to. During the repayment period, you can no longer draw on the line of credit, and your monthly payment will be for repayment of the loan plus interest.
A home equity line of credit is more flexible than a home equity loan. You can borrow money against it when you need it, and pay on just the interest, or elect to make payments against the principal. On the other hand, it's far more easy to remain in debt longer with a home equity line of credit than with a home equity loan, and you may find yourself facing unexpectedly large payments when the loan comes due.
Whether you choose a home equity loan or a home equity line of credit, you must pay off the balance of the loan when your home is sold. In either case, you should study your options carefully and choose the method of borrowing that's best for your situation.
