Q: Today’s question comes from Annie. She writes: What’s the difference between a home equity loan and a home equity line of credit?
A: A home equity loan and a home equity line of credit (HELOC) are similar in that they allow you to borrow against the equity of your home. They are different in a number of key ways. Let’s break it down.
A home equity loan is a one-time, lump sum that you borrow based on your home’s equity — or, in other words, the difference between what your home is worth and what you owe on your mortgage. You pay the loan back over a set time period (typically 5 to 30 years), with a fixed rate and fixed monthly payments. Home equity loans are commonly used by people who need cash for a large, one-time payment (for example, a home renovation) or to consolidate their debt.
On the other hand, a HELOC works more like a credit card. A financial institution will approve you for a certain amount of credit, based on your home’s equity. You can use the funds as needed during the “draw period.” The draw period typically lasts 5-10 years. During this time, you’re usually only obligated to pay the interest on what you borrow. When the draw period comes to an end, you’ll start repaying what you borrowed, plus any outstanding interest. A note about interest, too — interest rates with HELOCs are typically variable, not fixed. HELOCs are best for those who need ongoing access to funds, money to pay for recurring expenses, or to cover a project that is spread out over time.
A word of warning to those looking to tap into a HELOC or home equity loan. Both options use your home as collateral. If you don’t repay the loan, your lender could foreclose on your property.
