What’s the Difference Between Home Equity Loans and Home Equity Lines of Credit?

Most homeowners will say that the two best things about being homeowners are being able to say they own their own homes and not having to put money in a landlord’s pocket. An even better advantage is the equity you build in your home through the years—equity that you can get back in the way of cash. Learn about home equity loans and home equity lines of credit, two ways you can cash in on the value of your home, and how these loans are similar yet very different.

How Are They Similar?

Home equity loans and home equity lines of credit (HELOC) are similar in two ways.

  1. The amount you can borrow is based on the equity of your home, minus any liens you have on the home.
  2. You’re required to pay the money back.

For instance, if you owe $50,000 on a home valued at $200,000, you could borrow up to $150,000 on either of these loans. Both can be considered as second mortgages, and both are types of home equity loans. They both typically come with higher interest rates than conventional mortgage loans.

How Do They Differ?

There are actually several differences between home equity loans and HELOCs. With a home equity loan, you’re getting the money in one lump sum that you will then repay in monthly installments. An HELOC, on the other hand, allows you to draw out only the amount you need. HELOCS are often used for building or remodeling projects. For example, let’s say that you have $150,000 available home equity. Instead of receiving the entire sum, you can get an HELOC of $50,000.

Rather than make payments and pay interest on money you don’t yet have, you only take out what you need, as you need it, to pay contractors, etc. Each month you make a payment (often an interest-only payment) until your project is done. Then you take the amount you’ve used and convert it into a conventional mortgage loan. Here are some other differences between the two.

  • Home equity loans usually have fixed interest rates and HELOCs have variable rates.
  • With home equity loans, you know upfront how much you’re borrowing.
  • Home equity loans have the same fixed monthly payments.
  • Home equity loans are like conventional loans whereas HELOCS are more like credit cards in terms of only paying for what you’ve used.
  • Home equity loans come with higher closing costs and fees.

So, Is One Better?

Both the home equity loan and HELOCs offer various benefits to homeowners. The one you choose to use should depend on your needs and loan purpose. Home equity loans are often used for large purchases and expenses or to consolidate other debts. If you need a large lump sum, the home equity loan is your best bet. However, if you’re incurring regular expenses and are uncertain as to how much you’ll end up owing when it’s all said and done, the HELOC will work better for you.

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Posted on May 22, 2023