What are Home Equity Loans and Home Equity Lines of Credit (HELOC)?
Have you been considering a home loan to finance a major renovation or other large expense? Perhaps you have high interest credit card debt you’d like to consolidate into one convenient, lower interest monthly payment. There are a variety of reasons to convert the equity in your home into cash.
As a homeowner, the further you get into paying off your mortgage loan, the more equity you build in your home. Equity is simply the difference between any loan balance you have on your house and the current market value. So even if your mortgage is still fairly new but your real estate market is hot, you may have gained equity through an increase in market value.
When you need to borrow money for a large expense or to consolidate higher interest debt, a home equity loan or HELOC is usually the most affordable option. Because these loans are secured by the value of your home, the interest rates are much lower than what you’d get with a credit card or personal loan. Home equity loans and home equity lines of credit (HELOCs) are similar in that they both use your home as security.
What can Home Equity Loans and HELOCs be used for?
Many people use home equity loans to cover major upgrades to their homes. A HELOC can be used for this purpose too, but it can also cover unexpected repairs, as well as expenses totally unrelated to home improvement such as education and medical bills. Some people like to open a HELOC account before they need it, for peace of mind. Let’s understand how home equity loans and HELOCs differ.
Home Equity Loan vs. HELOC: What’s the Difference?
Home Equity Loan
A loan with a fixed interest rate and monthly payment. Receive the full amount of the loan upfront and then repay it over the agreed-upon term.
Home Equity Line of Credit
A HELOC works more like a credit card, though the interest rate is much lower. You get approved for a certain credit limit and then it is there whenever you want or need to use it. Monthly interest payments fluctuate depending on how much you borrow from the credit line. HELOCs usually have a variable interest rate and a defined term.
Key Differences Between a Home Equity Loan and HELOC
Disbursement of Funds
Home equity loans are paid to the borrower in one lump sum, while lines of credit provide the homeowner with checks or online banking to withdraw funds as needed over time.
Most HELOCs are available for up to 10 years. You can pay down a HELOC and then borrow more from the line of credit over that period of time. A home equity loan does not let you borrow additional funds from the loan.
Home equity loans have a fixed interest rate, while the interest rate on a line of credit is usually based on the Wall Street Journal Prime Interest Rate. The fixed rate adds a measure of protection against interest rate fluctuations, a fixed rate will likely be initially higher than a variable one.
A home equity loan has a monthly payment schedule that begins when you take out the loan. Your principal and interest payments won’t change from month to month, and at The First, you can choose a payment schedule anywhere from 3 to 20 years. HELOC payments are usually made during the 10-year draw period and usually interest only, however, principal can be paid over the term as well. Remaining balances at maturity will need to be paid in full usually by refinancing.
Despite their differences, home equity loans and home equity lines of credit do have two thing in common—First both are able to be paid early with no penalty and second both must be paid off when you sell your house.
How to choose between a HELOC and Home Equity Line of Credit
Now that you understand the differences between these two types of home loans, how do you know which one is best for your needs?
Think about how you plan to use the funds.
If you have a project in mind and know the exact amount you need, it may be easier to get a Home Equity Loan and repay it in predictable monthly payments that fit your budget.
On the other hand, if you’re not sure of how much need or need to “pay as you go” for something a HELOC gives you more flexibility.