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Home Equity Loan vs. Home Equity Line of Credit

News | 18th Jun 2012
Generally speaking, after buying a first house applying for a mortgage, homeowners are allowed to borrow more money using a home equity loan (HEL) or a home equity line of credit (HELOC). Basically, these two types of credits represent a second mortgage.  

What is the difference between a HELOC and equity loan?

With HELOC there is a predetermined limit for your funds. Normally, each month you have a minimum payment. Moreover, you can pay off as much as you want in order to cover the line. Repaying and drawing funds for the home equity line of credit is very much alike the method of repaying and drawing funds related to lines of credit, for example credit cards. On the other hand, a HEL offers a fixed payment per month and a lump amount of money. You have a predetermined time frame to pay off the money. Either case, the sum of money you receive is determined by your credit history, your income, the remaining amount of your mortgage, your home’s value and your debts. 

Advantages of HELOC and home equity loan

Both these loans are extremely appealing due to their advantageous interest rates. These are much lower as compared to interest rates imposed for standard bank loans or credit cards. The reason for this is that they’re being secured against your home. Moreover, the interest rate for a loan or home equity line is most of the times tax deductible. In order to find out what your particular situation is, you should speak with a tax advisor.      

What should you choose?

Normally, when you’re faced with ongoing cash requirements like medical bills or college tuition payments, you should apply for a HELOC. On the other hand, in case you require some money for one – time, specific purposes like major renovation or purchasing a car, it’s indicated to get a HEL. 

Costs comparison: Home equity loan vs. HELOC

HEL and HELOC normally come with a higher interest rate as compared with the interest rate for your first mortgage. When it comes to home equity loan, you have the option to choose between a fixed rate or a rate that’s adjustable, and changes as the prime rate fluctuates. In case you opt for the fixed rate, you will be able to schedule your budget taking into consideration the monthly payment. So, if the costs increase, your interest rate is not going to rise. When it comes to HEL, you should also think about the closing costs. 

When compared to a HEL, a home equity line of credit comes with a much lower interest rate. However, this only applies in the beginning, because afterwards, the rate is going to fluctuate as the prime rate fluctuates. Thus, as you can imagine, this type of interest rate is much more risky. 

With a HEL you know exactly what you have to pay every month. In contrast, with a HELOC you can borrow as much money as you want, but you don’t know what you have to repay each month. Moreover, for the HELOC there are no closing costs. You should always remember that both a HEL and a HELOC are offered against the value of your property.  

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