Home Equity Loans vs. Lines of Credit

There are two ways to cash in on your home’s equity: a home equity loan or a home equity line of credit (HELOC). We’ll explain the difference here to help you decide which is better for you.

How They Are Different

A HELOC works similarly to a credit card. You can withdraw money, up to your limit, as you need it. You will usually have a minimum monthly payment that you have to make, and you always have the option to pay more if you wish. With a HELOC, you are only responsible for paying back the money that you withdraw, regardless of your predetermined limit. A home equity loan, on the other hand, gives you a lump sum of cash up front, and you must repay this amount with fixed monthly payments over a finite period of time. For both types of loans, how much you can borrow will be determined by your credit, income, debt, the value of your home, and the outstanding balance of your mortgage.

Advantages

The biggest advantage to both home equity loans and HELOCs is the interest rates they can offer. Both types of loans can offer significantly lower rates than traditional bank loans or credit cards because they are secured by your home. Lenders can offer lower rates with secured loans because they face less risk. Another advantage is that interest payments are tax deductible with both loans.

The Costs

With home equity loans, you usually have a choice between a fixed-rate loan and an adjustable-rate loan. While a fixed-rate loan has an interest rate and monthly payment that remain the same, an adjustable-rate loan fluctuates according to market conditions. A home equity loan with a fixed rate can make budgeting easier, as you know exactly what to expect from your payments each month. On the other hand, an adjustable rate may be the cheapest option if you expect interest rates to fall. Keep in mind that you will also face closing costs if you choose a home equity loan. Also don’t forget that your home is at stake with these kinds of loans, so you don’t want to get behind on payments.

In general, a HELOC will offer a lower interest rate than a home equity loan, but because the interest rate of a HELOC varies, there is more risk associated with it. Instead of having a fixed monthly payment, a HELOC allows you to borrow only what you need and repay as little as just the interest each month. As an added benefit, a HELOC usually does not have any closing costs associated with it. The danger of a HELOC is that it provides relatively easy access to a large amount of cash, and you might be tempted to borrow more than you can repay. This could be a perilous situation for you because you stand to lose your house if you fall behind on payments.

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