Both allow you to borrow against the appraised value of your home, providing you with cash when you need it. Here's what the terms mean and the differences between a home equity line and loan that can help you figure out whether they're the right fit for you.
If you’ve built up equity in your home—if it’s worth more than the balance on your mortgage—you may be able to use part of that value to meet financial needs such as cash for home improvement projects, education expenses or to pay for unexpected costs.
Home equity lines of credit (HELOCs) and home equity loans (HELOANs) are two ways to achieve similar ends. But they are different, and understanding how each one works can help you decide whether one or the other might work for you.
What is a home equity line of credit?
Unlike a conventional loan, a home equity line of credit is something you establish ahead of time and use when and if you need it. In that way, it’s a little like a credit card, except with a HELOC, your home is used as collateral.
- A HELOC has a credit limit and a specified borrowing period, which is typically 10 years. During that time, you can tap into your line of credit to withdraw money (up to your credit limit) when you need it. You use the funds only when you need to, and you can continue to use the funds as you repay them.
- You only pay interest on the money you use.
- Most HELOCs charge variable interest rates. Those rates are tied to a benchmark interest rate and can adjust up or down.
- During the borrowing period, you’ll need to make at least minimum monthly payments on the amount you owe. Some HELOCs allow interest-only payments during the borrowing period. Other HELOCs require minimum payments of principal and interest.
- Once the borrowing period ends, you’ll repay the remaining balance on your HELOC, with interest, just like a regular loan. The repayment period is usually 10 or 20 years.
- You may be able to convert some or all of the balance you owe on a variable-rate HELOC to a fixed-rate loan.
What is a home equity loan?
If a HELOC resembles a credit card, a home equity loan is more like the original home mortgage. You borrow a specific amount, and then you make regular payments during a fixed repayment period.
- With a home equity loan, you apply for the amount you need.
- Most charge a fixed interest rate that doesn’t change during the life of the loan.
- Each payment, the same every month (if it is a fixed-rate HELOAN), includes interest charges and a portion of the loan principal.
How can you use home equity?
Your home may be your most valuable asset, and borrowing against your equity in it could free up cash for any of several purposes. You might use the money to:
- Finance a home-improvement project. Under the recent tax law, interest on a HELOC or HELOAN used to “buy, build or substantially improve” a home may be tax deductible. Consult your tax advisor.
- Consolidate what you owe on credit cards or other higher-rate debts into a single loan. Since your home is used as collateral for HELOCs and HELOANs, these loans may have lower interest rates than other kinds of loans.
- Cover emergency expenses. If you’ve used up the cash in your emergency fund, you could draw on a HELOC to pay for house repairs, medical bills or other unexpected costs.
- Help pay for education tuition and fees. Home equity line or home equity loan interest rates may be lower than rates on college loans.
Is a home equity line or loan right for you?
A HELOC gives you the flexibility of a financial backstop that’s there when you need it. If your roof needs repair or a tuition bill comes due when you’re short of cash, drawing on a home equity line of credit can be a convenient solution. You decide when to use the funds, and you pay interest only on the money you actually use. On the flip side, with a HELOAN, you get a lump sum of cash at loan closing, and know how much your monthly payments will be and how long it will take to pay off the loan.
With either, the amount you can borrow will depend on the value of your home and the amount of equity you have available. And with both, it’s important to remember that you’re using your home as collateral—and it could be at risk if its value drops or there’s an interruption in your income.
But if you qualify and your financial situation is stable, a home equity line or a home equity loan could be a helpful, cost-effective tool for making the most of your home’s value.
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What are the differences between a HELOC and HELOAN?
|Home equity loan||Home equity line of credit|
|An adjustable interest rate|| ||✓|
|A fixed interest rate||✓||✓|
(fixed rate loan option)
|Draw money as you need it|| ||✓|
|You only pay interest on the money you use|| ||✓|