A home equity loan and a home equity line of credit has many similar facets so it can be confusing sometimes. For instance, both programs let you borrow up to 85% of the value of your home and both use your house as a collateral. However, there are some very important differences that you need to take note of.
What’s the difference?
The main difference between the two is how you receive your money. A HEL lets you receive all your money in one lump sum whereas a HELOC allows you to draw the loan amounts whenever you are in need of the money, up to a predetermined amount. HELOCs usually have a draw period that is dependent on your terms. The draw period is the amount of time you have to draw your money from your HELOC. Once you draw the funds, the fund is charged an interest rate, usually the prevailing prime rate plus a margin. Once you draw funds, you will begin making payments on it. So in essence, a HEL works a lot like a conventional loan and the HELOC works like a revolving line of credit—much like a credit card but with a much lower interest rate.
Benefits of HEL and HELOC
These two loans have long been the loan of choice for those looking to consolidate debt or fix up their houses because of the low interest rates. The rates will almost always be lower than the rates of credit cards.
Which one is for you?
Generally, a HELOC is a good choice to meet ongoing cash needs, such as college tuition payments or medical bills. A HEL is more suitable when you need money for a specific, one-time purpose, such as buying a car or a major renovation.
Comparing the costs
Both HELOCs and HELs will carry a higher interest rate than a (first) mortgage. With a HEL, you option between an ARM or a fixed rate. With a HEL, you should also consider closing costs when you are figuring out the cost.
A HELOC usually carries a lower initial interest rate than a HEL. But since a HELOC adjusts according to the prime rate, there is always risk of your rate going up, especially if you do not pay down your HELOC quickly. There is a misconception that the prime rate doesn’t change much. That may be true when talking in terms of day-to-day. However, between 2003 to 2007, the prime rate changed from 4% to 8.25%—and doing so with only the rate changing 17 times. Unlike a HEL where your monthly payments are a set amount, a HELOC lets you get the funds when you need it and repay as little as interest only or as much as you want. With HELOCs, there are no closing costs (most of the time).
Do bear in mind that both a HEL and a HELOC requires your home as a collateral. So in both instances, you will lose your house if you cannot pay off your HEL or HELOC.
Like a mortgage, your HEL or HELOC’s interest may be taxable. But to find out more about that, you should consult your tax advisor.