Home
equity loans vs. lines of credit
If you're a homeowner, you can
borrow against the value of your house through either a home
equity line of credit (often called a HELOC or a line) or a home
equity loan (often called a HEL or loan). Both are essentially a
second mortgage.
What's the difference?
A HELOC is a form of revolving credit similar to a credit card.
It allows you to draw funds, up to a predetermined limit,
whenever you need money. There is generally a minimum payment
due each month, with the option to pay off as much of the line
as you want. With a HEL, you receive a lump sum of money and
have a fixed monthly payment that you pay off over a
predetermined time period. In each case, the amount you can
borrow is based on factors such as your income, debts, the value
of your home, how much you still owe on your mortgage and your
credit history.
Benefits
The appeal of both of these types of loans is their interest
rates, which are almost always lower than those of credit cards
or conventional bank loans because they are secured against your
home. In addition, the interest you pay on a home equity line or
loan is often tax deductible (consult a tax advisor about your
particular situation).
Which is best for you?
Generally, a HELOC is a good choice to meet ongoing cash needs,
such as college tuition payments or medical bills. A HEL is more
suitable when you need money for a specific, one-time purpose,
such as buying a car or a major renovation.
Comparing the costs
Both HELOCs and HELs usually carry a higher interest rate than
that of a first mortgage. With a HEL, you may choose either an
adjustable rate that fluctuates according to variations in the
prime rate, or you may opt for a fixed rate. A fixed rate
enables you to budget a set payment monthly without worrying
about increasing costs should interest rates rise. With a HEL,
there are also closing costs that you should consider.
A HELOC usually carries a lower initial interest rate than a
HEL, but its rate fluctuates according to the prime
rate, so there is more interest rate risk. Unlike a HEL,
where your monthly payments are a set amount, a HELOC enables
you to borrow funds as needed and repay as little as interest
only each month. In addition, there are generally no closing
costs when you open a HELOC.
Keep in mind, your home is the collateral for both a HELOC
and a HEL. If a HELOC's easy access to cash tempts you to run up
more debt than you can repay, or if you fail to make your
payments, you risk losing your house.
| |
Home
Equity Line of Credit (HELOC) |
Home
Equity Loan (HEL) |
|
| What you get |
Revolving credit, with a specific credit
limit of up to 100 percent of the value of your home
(its value minus all debts against it). Some lenders
will allow you to borrow up to 125 percent of the value
of your home. |
A fixed amount of money, up to 100
percent of your equity in your home (its value minus
your first mortgage debt and other debts). Some lenders
will allow you to borrow up to 125 percent of the value
of your home. |
|
| How to qualify |
You typically need to provide proof of
your income, home ownership, your mortgage and how much
equity you have in your home. An appraisal is usually
required as well. |
You typically need to provide proof of
your income and home ownership, and proof that at least
20 percent of the value of your home is paid off. An
appraisal is usually required as well. |
|
| How you repay
it |
Minimum payments (as little as interest
only) each month; eventually you have to repay the
entire sum borrowed plus interest. |
Fixed payments of interest and principal
over a fixed period of time. |
|
| How long it
lasts |
You have a 10- to 20-year period when you
can draw on the line (up to the credit limit), after
which you have a fixed period to pay off the outstanding
balance plus interest. |
The term of the mortgage can be as short
as a year or as long as 30 years. |
|
| Costs and fees |
Usually no closing costs, but may have an
annual fee. |
Closing costs that are lower than for a
first mortgage. |
|
| How you receive
the money |
You draw funds as needed, using special
checks or a credit card. |
You receive one up-front lump sum. |
|
| Interest rate |
The prime interest rate plus a margin
(which can vary from one institution to another). |
A fixed or adjustable interest rate. |
|
| Tax status |
Interest may be tax-deductible (consult a
tax advisor). |
Interest may be tax-deductible (consult a
tax advisor). |
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