Homeowners looking to tap into the equity in their homes are faced with choosing between a home equity loan and a home equity line of credit (HELOC). This can be a difficult decision, as each type of second mortgage loan has distinct benefits, and both are tax-deductible, but if you understand the basic differences in their structure, you can make an intelligent decision for you, your family and your financial future.
According to Bankrate, a revolving line of credit is “an agreement to lend a specific amount to a borrower and to allow that amount to be borrowed again once it has been repaid.” With a HELOC, you can borrow money against your equity up to a certain pre-determined amount. There is no set repayment schedule and in many cases, you are only responsible for paying the interest on what you borrow for the first several years. A HELOC has an adjustable interest rate, which is typically tied to the prime rate. Home equity lines of credit are best suited for homeowners who want the flexibility to borrow various amounts of money at staggered intervals. Because they are structured much like credit cards, home equity lines of credit are not the most prudent choice for homeowners who would be tempted to spend carelessly.
Home equity loans are lump sum loans with fixed interest rates and fixed payment schedules. With each monthly payment, you are paying down both the principal and the interest. A home equity loan makes the most sense for those who need access to cash in a lump sum and are using the money for long-term purposes, such as a home remodel or debt consolidation. They are also a smart choice for homeowners wary of variable interest rates.
Whichever type of loan you chose, you need to keep in mind that your home is the collateral. In a recent column on MSN Money, Andrew Analore, editor of Inside B&C Lending, an Inside Mortgage Finance publication, states, “People sometimes don’t understand that their house is on the line if, for some reason, they are unable to pay for their new computer or big-screen television.” It is always a smart idea to evaluate if what you are borrowing for is worth tapping into your most valuable asset.
