Article : Home Equity Line of Credit vs Loan

By Joseph V. Formale

When deciding between a Home Equity Loan against a Home Equity Line of Credit, first we need to determine what the money is being used for and how much money are we going to need. Generally, a HELOC (Home Equity Line of Credit) is a better choice for ongoing cash needs, such as college tuition payments or medical bills. These are recurring debts. When you need a set amount of money for a specific, one-time purpose, such as buying a car or a major home renovation, then you want to consider a HEL (Home Equity Loan).

When you're a homeowner, you have the collateral necessary to borrow against the equity value of your house through either a HELOC or a HEL. Both are essentially a second mortgage. The difference is a HELOC is a form of revolving credit, similar to a credit card. It allows you to draw funds whenever you need money, capped at a predetermined limit. There is generally a minimum payment due each month, with the option to pay off as much of the line as you want. With a HEL, you receive a onetime lump sum of money and have a fixed monthly payment that you pay off over a specific time period. In each case, factors such as your income, your debts, the value of your home, how much you still owe on your first or second mortgage, and your credit history will all be taken into consideration to determine the amount you can borrow.

The appeal of both of these types of loans is in their interest rates. They are almost always lower than those of credit cards or conventional bank loans, because they are secured against the equity value in your home. In addition, the interest you pay on a home equity loan or line of credit, is often tax deductible (consult a tax advisor about your particular situation). Unfortunately, both HELOCs and HELs usually carry a higher interest rate than that of a first mortgage. With a HEL, you may choose either an adjustable rate that fluctuates according to variations in the prime rate, or you may choose a fixed rate. A fixed rate enables you to budget a set monthly payment without worrying about increasing costs should interest rates rise.

With a HEL, there are also closing costs that you need to take into account. This refers to the money paid at closing to the lender. It may include one or more of the following fees: a loan origination fee, points, appraisal fee, title search and insurance, survey, taxes, deed recording fee, credit report charge and other costs assessed at settlement.

A HELOC will usually carry a lower initial interest rate than a HEL, but its rate fluctuates according to the prime rate, so there is always more of an interest rate risk. Unlike a HEL, where your monthly payment is a set amount, a HELOC enables you to borrow funds as needed and repay as little as interest only each month. Also unlike the HEL, there are generally no closing costs when you open a HELOC.

One important fact to keep in mind is your home is the collateral for both a HELOC and a HEL. If a HELOC's easy access to cash tempts you to run up more debt than you can repay, or if you fail to make your monthly payments on you HEL, you risk losing your house.

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