Understanding the difference between home equity loan and home equity line of credit

Homeowners often wonder how to use the value of their home to access low-interest financing. A loan or a home equity loan are two options available to you. To find out which one suits your needs better, check out some of the differences below.

Home equity loan (HEL)

A loan that taps into the value of your home is a great way to borrow money. This option allows you to receive a fixed amount and receive it in one lump sum. The amount you get is based on the value of your home, payment terms, proven income, and credit history. You can get it with a fixed interest rate, a fixed term, and even a fixed monthly rate. In addition, interest payments are 100 percent tax deductible.

Home equity line of credit (HELOC)

With a home equity line of credit, you don’t get your money all at once. Instead, you open a revolving credit facility that allows you to receive money as you need it. Your house serves as security for the opening of the credit account. Companies approve this type of account based on the appraised value of the property and subtracting the current balance of the existing mortgage. Some consider income, debt ratio, and credit history.

Unlike a HEL, with a HELOC you withdraw funds as needed over a period of time, typically five to 10 years. Plans vary and you may need to use special checks or a card to access your funds. Depending on your account, you may not have to borrow less than a set amount each time you access it. You may also be required to maintain a minimum outstanding balance. Some plans also require a certain initial payout.

After the “draw period” has expired, some HELOC providers allow you to renew the terms of the account. Not all lenders allow you to renew the plan. You also enter the “Repayment Period” after the “Drawing Period” has expired. Your lender may require you to repay the entire amount at this point. Others allow installment payments.

How do they differ

While both a HEL and HELOC allow you to leverage the value of your property to access financing, there are two key differences. These are the interest rates and the repayment terms.

With a HEL you get a fixed interest rate. This way you know what your interest rate is from month to month. This also solidifies your payments, making it easy to budget for each month.

However, a home equity line of credit usually has an adjustable interest rate. This means that the monthly interest payment can shift depending on the index. Lenders traditionally add a margin of a few percentage points to the prime rate. You should ask the lender what index is used, what the calculated margin is, how often the interest rate is adjusted, and what the high and low interest rates are.

Since the interest rates are variable, the monthly installments fluctuate. In addition, you could only be responsible for paying back the monthly interest during the drawing period and generally only pay once the repayment period has started.