Home Equity Loan vs. Home Equity Line of Credit

If you are a homeowner, you hold the keys to one of the most affordable sources of credit - literally. That’s right, your house can get you some of best loans on the planet with lower interest rates, better terms and more cash than unsecured loans. The two most popular types of financing that use your home as collateral: a home equity loan (HEL) and a home equity line of credit (HELOC). There are pros and cons to each of these debt instruments, but before we get into the details, let’s discuss home equity.

Home Equity

Home equity is the difference between how much you owe on your mortgage and the value of your home. This is actually what you are borrowing against when you get a home equity loan or home equity line of credit. In a way, your home is like a giant piggybank. Cash value accrues as you pay down your mortgage or increase the value of your home. For example, if you owe $50,000 on your home, which is worth $90,000, you have $40,000 worth of home equity. But in order to access that cash value and apply it to other expenses - such as education, home improvements, medical bills, vacations and debt consolidation - you have to figuratively “break open” the piggy bank. This is what a home equity line of credit or home equity loan does.

Home Equity Loan

A home equity loan is essential a second mortgage. You receive a lump sum of cash all at once and repay in fixed monthly installments. Like your first mortgage, interest is rolled into your monthly payments. You continue make payments until your debt is repaid. Longer term home equity loans accrue more interest, while shorter term home equity loans accrue less.

Benefits of Home Equity Loans: Home equity loans make the most sense for one-time expenses, such as buying a new car, building addition to your house or consolidating debt.

Drawbacks of Home Equity Loans: HELs are less flexible and come with closing costs, similar to your first mortgage. You may also face penalties if you pay down your home equity loan early.

Home Equity Line of Credit

A home equity line of credit is a revolving credit account and works like a credit card. You are allowed to borrow up to a certain amount. Your minimum monthly payment depends on how much you have withdrawn and you stop accruing interest when you pay down your balance. Home equity lines of credit often have lower interest rates than credit cards.

Benefits of Home Equity Lines of Credit: Home equity lines of credit are ideal for ongoing expenses, such as tuition or medical bills. You can borrow as much as you need, when you need it, thereby minimizing the overall amount of interest you pay. HELOCs often carry annual fees, but these are usually less than the closing costs associate with a HEL.

Drawbacks of Home Equity Lines of Credit: With variable interest rates, HELOC interest rates may fluctuate more than a HEL interest rate.

Conclusion

HELOCs and HELs are a convenient, low-cost way to finance life’s unexpected and expected expenses. However, remember that you are using your home as collateral - if you default, you could lose your home. Use home equity loans and home equity lines of credit wisely.