Using Your Home Equity: Loan or Line of Credit?

While a home equity loan and a home equity line of credit (HELOC) may seem interchangeable, they’re actually different from one another.

With the home equity loan, you must decide how much you want to borrow at closing and then make monthly payments, similar to a mortgage.

On the other hand, the HELOC offers you borrowing potential. More like a credit card, a HELOC allows you to borrow up to a certain amount and then carry the debt, or pay it off and re-borrow as you need.

If you’re considering a home equity loan, make sure you know the pros and cons before you sign on the dotted line.

Advantages of a home equity loan

Here are reasons to get a home equity loan:

You know exactly how much you are borrowing. The interest rate is usually fixed, so the payments are predictable. There is no way to increase the line later, so you cannot overspend. All the interest is tax deductible. Interest rates are usually low.

If you want to take out a certain amount of money immediately—if you need a new roof or car, for example—a home equity loan makes the most sense. You’ll get a fixed interest rate and will know exactly what your monthly payments will be. And you won’t leave yourself open to the temptation to overspend later since you will be borrowing a set amount.

Also, since you’ll be using your house as collateral on the loan, you’ll likely get a better interest rate than you would if you used a credit card to cover the purchases, and the interest you pay may be tax deductible.

Disadvantages of a home equity loan

Getting a home equity loan has some disadvantages, including these parameters:

You are locked into borrowing a certain amount of money. You must begin paying interest immediately. You cannot pay it down later and re-borrow.

There is no flexibility when it comes to the amount of a home equity loan. You must know up front how much you need to borrow. And since you are borrowing all the funds at once, you’ll start paying interest immediately. With a HELOC, you can get a line of credit and not tap it until you’re ready to use the funds.

Another possible big drawback: You cannot access the funds again. With a HELOC, you can continue to borrow off the credit line as long as you’ve paid off what you owe, as with a credit card. This makes things like financing home improvements smoother, since you can borrow money again when something else comes up.

You won’t have this option with a home equity loan. Once you borrow the money, you’ll have to pay the loan back and reapply for another loan if you realize you need more funds.

Updated from an earlier version by Laura Sherman. 

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