There are advantages and disadvantages to both home equity loans (HELs) and home equity lines of credit (HELOCs), making the choice between the two dependent on your unique needs and circumstances.
Amount You Can Borrow
Both home equity loans and lines of credit allow you to borrow up to 100% of the equity in your home. In some cases, lenders will even allow you to borrow up to 125% of your home equity.
Both HELs and HELOCs require you show proof of the following:
* personal income;
* ownership of the home ownership (ie. Title);
* current mortgage;
* current value of the home (via a professional appraisal).
A home equity loan additionally requires proof that at least 20% of the home’s value has already been paid off. So, if you have yet to pay off at least that much of your home’s value, then your choice of which instrument to apply for is made for you.
Purpose for the Money
If you wish to use the money borrowed in a lump sum for a single, one-time expense (ie. a particular renovation, an emergency, a desired purchase, or to consolidate debt), then a home equity loan may be the better choice.
If you don’t have a single, particular use for the money in mind and don’t think you’ll need the money all at once but rather feel that you’ll be needing it on a periodic basis (ie. for lengthy and drawn-out remodels, medical bills, or college tuition payments that will be made in intermittent sums), then a home equity line of credit may be the better choice.
The HELOC gives you a flexibility that a home equity loan does not, allowing you to borrow however much you need, at the time that you need it, rather than taking out more than you need at once and, subsequently, paying interest on the whole amount from day one. Rather than receiving a fixed lump sum all at once, with a HELOC, you’re usually given checks or a credit card to use on an as needed basis. Part of the risk inherent in home equity lines of credit is that you could end up borrowing more over time that you can realistically pay off.
Interest Rate and Monthly Payments
Both HELOCs and HELs generally carry lower interest rates than conventional bank loans and credit cards, as they are secured by borrowing against your home. They both, however, commonly carry interest rates higher than that of your primary mortgage (or first mortgage). Interest on both instruments may be tax deductible (to find out, check with your tax advisor).
Interest paid on both of these instruments (HELs and HELOCs) is also usually tax deductible, whereas interest paid on conventional bank loans and credit cards is not.
The interest rate and monthly payments on a home equity loan is fixed, allowing you to budget accordingly, though in many cases you could opt for an adjustable rate (though that isn’t always advisable). The payment term on a home equity loan is also fixed, meaning that you must pay it off in full by a predetermined point in time.
The interest rate and monthly payments on a home equity line of credit is not fixed and will fluctuate over time, based on fluctuations in the prime rate, so budgeting accordingly can be much more challenging. The interest on a home equity line of credit is also typically higher than that of a home equity loan. The payment term on a home equity line of credit, however, is not fixed, and so long as you keep making minimum payments, you could conceivably stretch out the payment period indefinitely.
Like other loans, a home equity loan comes with certain closing costs that must be covered in advance of receiving the loan.
There are usually no closing costs involved in a home equity line of credit, though you may have to pay an annual fee.
Remember, that in either case, your home is considered the collateral for payment.