Difference between a home equity loan and line of credit
When you choose how to borrow from the available Glossary Term: equity in your home, you are often making the choice between a home equity loan and a home equity line of credit. The two differ in the way you access your loan funds, and by the Glossary Term: interest rates they offer. Home equity loans have a fixed-rate, while home equity lines of credit have a variable rate.
Fixed-rate option: home equity loan
A home equity loan allows you to borrow the entire amount of your loan all at once. This fixed-rate loan generally has a higher interest rate than a home equity line of credit; however, with a fixed rate your monthly payment will stay the same for the entire term of the home equity loan. This could be beneficial if interest rates were to rise above your fixed rate. It also protects you from payment surprises and is very straightforward. This loan type may be a good option for you if you have a monthly budget you need to stick to, or if you prefer payment stability.
Variable-rate option: home equity line of credit
A home equity line of credit allows you to use as little or as much of your credit line as you need, up to your pre-set limit. Home equity lines of credit generally offer lower rates than fixed-rate home equity loans; however, they come with variable rates that change periodically according to the changes of a financial index, for example, The Wall Street Journal Prime Rate. The interest rate on the line of credit is determined by adding the rate of the index (which can vary over time) to a margin (which is determined by your lender and remains fixed for the life of the line of credit). The interest rate will adjust with movement in your loan's financial index, so your payment may vary from month to month. If the index goes up, so will your rate and interest payment, whereas if the index goes down, so will your rate and interest payment.
With variable-rate lines of credit, there are three major considerations:
- The rate is subject to change and could increase, which would also increase your interest payments. This can make budgeting for the future unpredictable.
- Your lender may also offer you a Fixed-Rate Loan Option. Bank of America home equity lines of credit include this fixed-rate conversion option. This would allow you to convert all or just a portion of the outstanding variable rate balance on your home equity line of credit to a fixed rate, resulting in stable payments for the portion of the balance you convert to that fixed rate. You may choose this option if you want to be protected from rising interest rates.
- During the draw period, lenders often provide different payment options such as interest-only or principal-and-interest payments. Bank of America home equity lines of credit (HELOCs) require Glossary Term: variable-rate monthly minimum payments that include principal and interest during both the draw and the repayment period ($100 minimum required). Payments may change based on balance or interest rate fluctuations, or if additional principal payments are made. You may also have the option to pay down the principal balance all the way to zero whenever you like.
It’s recommended that you pay more than the monthly minimum payment so that you’re paying down additional principal. When you pay down additional principal each month, not only will you reduce your overall debt more quickly, you will also pay less interest over the life of the loan