Understanding Home Equity Loans Versus Lines of Credit

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Home equity loans and home equity lines of credit have become increasingly popular consumer financing options. A home equity loan or line of credit can give you access to the funds you need in the event of an emergency by allowing you to borrow against the equity in your home.Interest rates on home equity loans and lines of credit are often lower than those for credit cards, making them a more appealing option for homeowners. An added benefit is that the interest you pay may be tax deductible. Be sure to consult your tax advisor for further information about deductible interest on loans or lines of credit.This all sounds great, right? So, how do you determine whether you need a home equity loan or a home equity line of credit?Once you understand the major differences between these types of loans, you’ll better understand which one will best meet your needs.Home equity loansAlso known as a second mortgage, a home equity loan (HEL) gives you access to a single lump sum that you agree to pay back on a regular monthly basis over a time span of 10 to 30 years. With this type of loan, you can get either a fixed interest rate or the flexibility of a variable interest rate.Often best-suited for large one-time expenses, home equity loans are beneficial when you need money for things such as short-term home improvements or a new car. It’s possible to be approved for up to 100 percent of your home’s equity, and an appraisal usually is required as part of the application process to help determine the market value of your home.Home equity line of creditsA home equity line of credit (HELOC) functions like a credit card, by providing you with a revolving line of credit. You can borrow as much (or as little) money as you need at any given time, up to a predetermined maximum limit, rather than receiving one lump sum as you would with a home equity loan. With this type of loan, you usually receive a variable interest rate based on the fluctuations of the prime rate.When you are approved for a home equity line of credit, you will be given checks or a credit card to use when you want to draw upon your line of credit. In most cases, your monthly payments will be on the interest only, and you will be responsible for paying back the principal at the end of your draw period. Once the principal is repaid, it becomes available for you to borrow again.One of the major benefits of a home equity line of credit is that is flexible and like a home equity loan can also be used for anything you want; however is often best-suited for long-term, ongoing expenses such as funding long-term housing renovations, medical bills, or college tuition. Assuming creditworthiness, the amount you can be approved for is based upon a percentage of your home’s appraised value, minus what you still owe on your mortgage.It is important to note that when you commit to a home equity loan or line of credit, you are using your home as collateral. Be sure you understand the terms of the loan or line of credit, and only commit to an amount that fits comfortably within your budget. Because you will be on a recurring payment schedule, and know exactly how much the amount of your monthly payments will be over the entire term of your loan, you should be able to budget for your payments in advance and not have to worry about the chance of foreclosure. Plan ahead, and be careful not to over-extend yourself.

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