Posted by Christine Owens on August 3, 2017
Understanding the Difference Between a Home Equity Loan and a HELOC
When you purchase a home, your down payment and each mortgage payment you make slowly but surely increases the equity you have in your home. When you sell your home you gain access to that equity which can be rather substantial but, as long as you live in your home, you generally do not have access to that equity. But, if you need money for things like home repairs or renovations, education or other expenses, you do have options – you can take out a home equity loan or a home equity line of credit (HELOC). These two options are commonly referred to as taking out a “second mortgage” on your home. At first glance, the concept sounds great – get access to money that will theoretically be yours eventually and often at a lower interest rate than other types of loans. It is important to keep in mind that because you are borrowing against the equity in your home, if for some reason you default on your payments, the bank could foreclose on your home. There are certainly pros and cons to each option and they should be weighed carefully before you draw on your home’s equity.
The primary difference between a home equity loan and a HELOC is that with a home equity loan, you receive your cash up front in a lump sum payment and then repay it over time (often with a fixed interest rate, but with a HELOC you receive a line of credit that you can borrow against (often with an adjustable interest rate) much like a credit card. Another primary difference between a home equity loan and HELOC is that with a HELOC you only pay interest on the amount you use but with a home equity loan you pay interest on the entire lump sum you borrow. With both a home equity loan and a HELOC, the interest you pay each year is tax deductible.
It is important to understand home repayment is facilitated with a home equity loan and a HELOC. With a HELOC there will be a draw period or repayment period during which the minimum monthly payment is often simply the interest. But, once the repayment or draw period ends, you will be expected to repay the entire amount or refinance your mortgage (which could be unfavorable if interest rates have risen significantly). With a home equity loan, you will borrow one lump sum and have a predetermined length of time to pay back the full amount. For example, you may have anywhere from 10-30 years to make fixed monthly payments until the loan is paid off. If you are interested in accessing the existing equity in your home by getting either a home equity loan or home equity line of credit, speak to a qualified, experienced and trusted mortgage lender to begin the process of acquiring the money you need.