Home Equity Loan vs. Home Equity Line of Credit

No matter how carefully you choose your words, home equity loan, home equity line of credit and second mortgage are all means of using the equity (amount that a home is worth (value) minus the total loan amounts against it) in a home to obtain a loan in which the home is held as collateral. If you don’t pay this loan back as agreed, the lender can come and take your house.

All of these attached-to-your-home loans come in a variety of options, like fixed and adjustable rates, with or without prepayment penalties, and an array of years/terms for your borrowing and repayment pleasure. Any of these loans hold the ‘second position” on your property deed, as the first position is held by your primary mortgager. Your homeowners insurance policy will need to reflect this information just incase a large claim in filed- the insurer will need to know who to pay the settlement to. 

Typical uses for the funds include home repairs, bill consolidation and college tuition.  No matter what the money is used for, the interest you pay on the loan is usually tax-deductible.

The Differences

If you choose to have your loan paid to you in one lump sum, a basic home equity loan or second mortgage is what you’re getting.  You will have a preset payment amount for the next 10 to 30-years, depending on your agreed upon terms If you opt to have the money accessible to you as you need it, paying back any funds that you use as you go along, that’s a home equity loan of credit, or HELOC as it is commonly referred to in the mortgage and finance industry.  These loans are very popular, as you only pay interest on the money you use, with more cash available should you need it- very similar to a credit card with an all important tax deduction come April 15.

The Scenarios

Say that you need money for home improvements, repairs, or additions.  You could get a traditional home equity or second mortgage to increase the value of your home, as long as you know for sure how much the construction will cost.  If you would rather have the money available to you as needed, a HELOC would definitely be a more flexible option for you.

But, if you feel as though that a large open line of credit would steer you in the direction of wasteful spending, like a $400 faucet for your new bathroom, the classic second mortgage option could be a more viable option for you. The fixed amount home equity loan is definitely a better idea if you need help to budget your money.

The Caveats

As with any large loan or purchase, it’s mandatory that you read all fine print, as when it comes to interest and your money, you need to weigh out all options.  Many HELOC loans come with an “interest only” option in which you only pay interest and pay nothing on the principle- unless of course you want to. This can turn into a lot of money paid with no balance reduction if you’re not careful.

If you do choose the HELOC, you may get a credit card to accompany the loan- if you feel that you will be tempted to use this money on frivolous purchases, you may want to stay away from such a tempting situation. 

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