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September 20, 2023 Personal Finance

HELOC vs. Home Equity Loan: What is the Difference? 

As you learn more about home equity, you are bound to come across the terms Home Equity Line of Credit, or HELOC and Home Equity Loan. Both are options to use the equity of your home to fund other expenses in your life. HELOCs and Home Equity Loans function differently and cater to different financial goals. Let’s look at the key differences between HELOCs and a home equity loan.

HELOC: Definition & Benefits

A Home Equity Line of Credit is exactly that, a line of credit you take out, similar to a line of credit you get from a credit card. Just like a credit card, you are given a credit limit based on how much you can use of your home’s equity. There are a few things that set HELOC’s apart.

Flexibility: You can borrow money, payback the money, and borrow again as long as you stay within your approved credit limit. This offers lots of flexibility over the drawing period, which is typically 5 to 10 years long.

Interest Rates: HELCOs most often come with variable interest rates, which means that the monthly payment you make can change or fluctuate depending on the interest rate and market conditions.

Lower Initial Payments: During the drawing period, you can make payments on only the interest, meaning lower monthly payments initially. You can also pay down your interest or principle in the drawing period, meaning you would have lower payments during the repayment period.

Many Uses: HELOCs can be used for a variety of purposes and can help you get ahead of debt by consolidating all your debt into one payment. It can also help you with home renovations, education expenses, and more.

Home Equity Loan

A Home Equity Loan is most well-known as a second mortgage. This loan offers a lump sum of money that is borrowed against a person’s home equity. It operates much more differently than a HELOC and more like a loan or mortgage.

Fixed Interest Rate: Just like a mortgage, a Home Equity Loan comes with a fixed interest rate that locks in what your monthly payments will look like from the very beginning.

Lump Sum Disbursement: You receive the money you want all at the same time once the processes for the Home Equity Loan is complete. This makes it perfect for large one-time expenses like major home improvements or debt consolidation. Once you have it, you repay it with set monthly payments, just like a mortgage.

Simplifies Budgeting: Because you get the money all at once with a fixed interest rate, you always know what your payment will be and can budget month to month more effectively.

Close-End Loan: Once you receive the amount of money you wanted, you cannot borrow against the Home Equity Loan again, but would need to reapply for a new loan in order to get any other needed funds beyond what you originally got.

Which One Do I Choose?

There are a few other things that you can consider as you decide which of these two options are best for you. Ultimately, it depends on your preferences and needs.

Usage: Are you planning on having one major expense and that is it? Or are you not quite sure what your expenses will be over a period of time? For one-time purchases, a Home Equity Loan may be more suitable, while continuous expenses may lead you to want the flexibility of a HELOC.

Interest Rates: Do you like the idea of having a fixed interest rate or one that it more variable? It may also help to consider the recent treads of interest rates and the predictions of future interest rates as these would affect your payment amount.

Repayment Strategy: Are you interested in doing interest only payments during the drawing period or would you prefer fixed payments that are paying your principle and your interest? This may also sway your decision of choosing a HELOC or Home Equity Loan.

Loan Term: How long do you want to be paying back your Home Equity Loan or HELOC? Typically Home Equity Loans have shorter loan terms, but then you lose the drawing period that comes with a HELOC.

Before making a decision, talk through each of these points and decide what works best for you, your project, and your budget. Hopefully by knowing these differences you can make an informed choice!