Homeowners often wonder how they can use their home’s equity to access low-interest financing. A home equity loan or line of credit are two options available to you. To find out which one best suits your needs, check out some of the differences below.
Home Equity Loan (HEL)
A loan that takes advantage of the equity in your home is a good way to borrow money. This option allows you to obtain a fixed amount and receive it in a single payment. The amount you receive is based on your home’s value, payment terms, verifiable income, and credit history. You can get it with a fixed rate, a fixed term, and even a fixed monthly fee. Plus, interest payments are 100 percent tax deductible.
Home Equity Line of Credit (HELOC)
With a home equity line of credit, you don’t get all your money at once. Instead, you open revolving credit, which allows you to receive money when you need it. Your house is used as collateral to open the credit account. Companies approve this type of account based on the appraised value of the property and subtracting the current balance of the existing mortgage. Some consider income, debt ratio, and credit history.
Unlike a HEL, in a HELOC you withdraw funds as needed over a period of time, usually five to ten years. Plans vary and you may have special checks or a card to use to access your funds. Depending on your account, you may need to borrow no less than a certain amount each time you access it. You may also need to maintain a minimum outstanding balance. Some plans also require a specific initial withdrawal.
After the “withdrawal period” ends, some HELOC providers will allow you to renew your account terms. Not all lenders allow you to renew the plan. Also, after the “withdrawal period” is over, enter the “repayment period”. Your lender may ask you to pay the full amount back at this time. Others allow you to make quotas.
What is the difference between them?
While both HEL and HELOC allow you to leverage the value of your property to gain access to financing, there are two important differences. Those are the interest rates and the repayment terms.
With a HEL, you get a fixed interest rate. This means that you know what your interest rate is from month to month. This also makes your payments fixed, making it easy to budget each month.
However, a home equity line of credit generally has an adjustable rate. This means that the monthly interest payment can vary depending on the index. Lenders traditionally add a margin of a few percentage points to the prime rate. You should ask the lender what index is used, what is the margin charged, how often the rate is adjusted, and what is the rate cap and floor.
Since the interest is adjustable, the monthly payments fluctuate. Also, during the withdrawal period, you may be responsible for repaying the monthly interest only, and not paying the principle until after the repayment period begins.