What Is the Difference between a Home Equity Loan vs. Line of Credit?
Maybe you’d like to update your kitchen or bathroom, maybe it’s time to pay for your child’s college education, or maybe you’d like to make your home more energy efficient—whatever it is, you’ve most likely thought about tapping into the equity you’ve accumulated in your home. If so, you’ve probably come across two primary options for doing so: a home equity loan and a home equity line of credit (HELOC).
While both options allow you to borrow against the value of your home, understanding the differences between these financing vehicles is essential for making informed decisions about leveraging home equity. In this article, we’ll check out the differences between a home equity loan and a HELOC, shedding light on their key characteristics, benefits, and considerations.
What are the primary vehicles for home equity financing?
There are two primary ways to borrow on the equity you’ve built up in your house: a home equity loan and a home equity line of credit (HELOC). A home equity loan, also known as a second mortgage, provides borrowers with a lump sum of money upfront, which is repaid through fixed monthly installments over a predetermined period. In contrast, a HELOC offers a revolving line of credit, enabling borrowers to access funds as needed within a specified draw period, similar to a credit card, followed by a repayment period.
Understanding the differences between these options goes beyond the method of fund disbursement. Repayment structures, interest rates, borrowing flexibility, and access to funds all play a role in determining which option aligns better with individual circumstances. Furthermore, factors such as risk tolerance, borrowing needs, and future financial plans will influence the suitability of each option.
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What’s the difference between a home equity loan and HELOC?
The main differences between a home equity loan and a home equity line of credit (HELOC) lie in the way funds are disbursed, repaid, and the borrowing flexibility they offer. Here’s a breakdown of the key distinctions:
With a home equity loan, borrowers receive a lump sum of money upfront. This means that upon approval of the loan, the entire loan amount is disbursed to the borrower, and they can use the funds as they see fit. Whether it’s for a specific home improvement project, debt consolidation, or other financial needs, the entire loan amount is available from the start.
In contrast, a HELOC operates more like a credit line. Rather than receiving a lump sum, borrowers are granted access to a predetermined credit limit. They can draw from this line of credit as needed during the draw period, which typically lasts 5-10 years. They have the flexibility to borrow funds incrementally or in one lump sum, depending on their needs. Payments during the draw period are typically interest only, but borrowers can save money during that time by also making principal payments. During the draw period, as they pay back the amount borrowed, the funds become available for use again. The draw period is followed by a repayment period, during which no further borrowing is allowed, and the borrower starts making monthly principal and interest payments.
Another distinction between a home equity loan and a home equity line of credit (HELOC) lies in the borrowing flexibility they offer. With a home equity loan, borrowers receive a fixed lump sum upfront, and the borrowing amount is predetermined. This means that once the loan is approved, borrowers cannot access additional funds beyond the initially agreed-upon loan amount. The repayment structure is based on the predetermined loan terms, with fixed monthly payments that encompass both principal and interest.
A HELOC works more like a credit line in that you can borrow and repay repeatedly within the draw period, which usually lasts around 5-10 years. During the draw period, you typically pay interest only on the amount borrowed. After the draw period ends, you enter the repayment period, during which you can no longer borrow and must repay both principal and interest. This flexibility allows homeowners to use the funds when necessary and tailor their borrowing to their specific financial needs.
Home equity loans typically have a fixed repayment schedule with fixed monthly payments over a predetermined term. HELOCs, on the other hand, typically have two phases: the draw period and the repayment period. During the draw period (usually 5-10 years), you may only need to make interest payments on the amount borrowed. In the repayment period (generally 10-20 years), you repay both principal and interest.
Typically, home equity loans come with fixed interest rates, which remain unchanged throughout the loan term. This stability provides borrowers with predictability in monthly payments, as they know exactly how much interest they will be paying over the life of the loan. Fixed interest rates are beneficial when borrowers prefer consistency and want to plan their budget accordingly.
HELOCs often feature variable interest rates. The interest rate for a HELOC is usually tied to a benchmark rate, such as the prime rate, which can fluctuate over time in response to changes in the market. This means that the interest rate on a HELOC can rise or fall, potentially impacting the amount of interest paid by borrowers. While variable interest rates can initially offer lower rates than fixed options, they introduce an element of uncertainty as borrowers may experience rate increases over time.
Access to Funds
With a home equity loan, borrowers have immediate access to the entire loan amount. Once the loan is approved and disbursed, the funds are available for the borrower to use as desired. This lump sum provides a straightforward approach, particularly when there is a specific expense or project in mind that requires a substantial upfront payment.
In contrast, a HELOC offers ongoing access to funds during the draw period. The draw period is a specified timeframe, typically 5-10 years, during which borrowers can borrow from the revolving line of credit as needed, up to the predetermined credit limit. This flexibility allows borrowers to tap into the available funds whenever necessary, similar to using a credit card or a personal line of credit. Borrowers can borrow, repay, and borrow again within the draw period, making it suitable for recurring or unpredictable expenses.
Purpose of Use
Both options allow you to use the funds for various purposes, such as home improvements, debt consolidation, education expenses, or other financial needs. The choice between a home equity loan and a HELOC depends on your specific goals and borrowing requirements.
Putting it all together
Each homeowner’s financial situation is unique, and what may work for one person may not be the ideal choice for another. It’s important to carefully consider your financial situation, goals, and preferences before choosing between a home equity loan and a HELOC. Evaluate the terms, interest rates, repayment options, and potential risks associated with each option. Consulting with a financial advisor or lender can help you make an informed decision that aligns with your individual circumstances.
Norway Savings Bank Home Equity Loans & Lines of Credit
At Norway Savings Bank, we want to simplify the borrowing process. Our local lending experts meet you where you are, take time to understand your needs and when we’ve found the right option, make the application process fast and easy. Whether you want to add another bathroom, pay for a child’s education or fix a roof, we are here to help. Ready to get started? Check out our Home Equity page, or contact a lender.