Home Equity Loans (HEL) vs. Home Equity Line of Credit (HELOC)

HELOCs and Home Equity Loans: What’s the big difference?

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Home equity loans (HELs) and home equity lines of credit (HELOCs) are both ways that you can use the value in your home to pay bills, medical expenses, or to finance home improvements and renovations. While home equity loans provide a large, lump-sum payment usually in the form of a check, a HELOC simply provides access to credit based on the equity in your home. As a revolving line of credit, a HELOC functions more closely to a credit card than a traditional mortgage -- and many HELOCs actually come with one.

Why get a HELOC vs. a Home Equity Loan?

Since you’ll get much more money at once with a home equity loan, it might make more sense to get one when you need to cover a large, one-time expense. Examples include medical bills after a serious emergency, a kitchen renovation, or a new roof after a hurricane. But, if your expenses are smaller and more regular, such as paying for college tuition fees on a regular basis for several years, it might make more sense to get a HELOC.

While you’ll begin paying a monthly payment of both principal and interest immediately with a home equity loan, if you get a HELOC, you’ll only pay interest during the draw period, which is often between 5-10 years. After the draw period is over, you’ll no longer be able to take money out of the HELOC. At this point, you’ll begin making payments on both the principal and the interest during what’s referred to as the amortization period.

If you do decide to get a HELOC, it’s essential to make sure you understand the exact terms of the loan/credit agreement. Ask if there’s a minimum withdrawal requirement upon opening your account. Check if there are minimum or maximum withdrawal requirements that may be assigned on a monthly or yearly basis. If you just want to open a HELOC as a way to supplement your income during a particularly tough period, you won’t want to be stuck paying years of interest on a required minimum withdrawal amount.

Plus, it’s also a good idea to ask exactly how you can withdraw money from your HELOC. The most common options are checks and credit cards, but different HELOCs have different rules, so you’ll want to get the one that fits you best.

How are interest rates calculated on HELOCs vs. Home Equity Loans?

For home equity loans, annual percentage rates (APRs) are calculated based on the size of the loan, the credit score of the borrower, and the LTV (loan to value ratio). Currently, rates in many areas average around 5%, though they vary based on both state and county. In contrast, HELOC interest rates are calculated based on an index rate, such as the prime rate or the LIBOR rate. Right now, the average HELOC rates in the U.S. can vary from 4 - 8% -- though they are adjustable, so this can change at any time.

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