What's the Difference Between an Equity Loan and a Line of Credit
Home Equity Loans and Home Equity Lines of Credit are valuable financial tools, but many people have trouble understanding the difference between these types of loans. Both loans are made against the equity in a piece of residential real estate. Typically, this is equity that has been built up by the homeowners through years of on time mortgage payments, however people can also qualify for these loans if the current value of their home is more than what they currently owe. While there are a number of websites that can give estimates, home value is ultimately determined by a bank appraiser.
Home Equity Loans have been around for decades, and are commonly used when homeowners need one large sum of cash. It is common to see people use Home Equity Loans for major remodeling or repair projects, to pay off bills such as credit card debt or hospitalization, and/or pay for a one-time expense such as a wedding or college tuition. Home Equity Loans are typically given by banks for up to 80% of the difference between the home’s value and the amount owed on the first mortgage.
For example, a homeowner who had a remaining balance of $50,000 on her mortgage and a home value of $200,000 would have $150,000 in equity. A lender would typically be willing to loan out about 80% of this sum, or $120,000. Of course, specific rules will vary from bank to bank.
Interest rates for Home Equity Loans can be either fixed or adjustable. Fixed rate Home Equity Loans are the most common, and will require the borrower to pay a set amount every month until the loan is paid off. Adjustable rate loans can have varied payment amounts depending on the market interest rates. It is possible in some cases for payments to be delayed on Home Equity Loans by a few months, but this must be stated in the original loan paperwork.
Home Equity Lines of Credit are a newer financial product than Home Equity Loans. Home Equity Line of Credits typically function more like credit cards than a mortgage; in fact, many Home Equity Line of Credits can be accessed through a credit card. With a Home Equity Line of Credit, a bank or lender will typically establish a maximum amount of credit that they are willing to extend to the borrower, similar to the maximum charge amount on a credit card. The borrower can then choose how much of this amount he or she would actually like to use. Payments vary by the total amount of their credit the borrower has used.
Home Equity Line of Credits are usually good products for people who are looking for a safety net, have several expected expenses they need money for, and/or for people who are unsure of the final cost of planned events. For example, this type of loan is great for people who are looking at doing a series of remodeling projects. Expenses can be charged to the Home Equity Line of Credit as they come up, and can either be paid in full in a short amount of time or extended over several months or years. Many families use these types of products to cover college tuition as they can pay the school in one lump sum, but still make payments on the tuition at a more flexible schedule.
Home Equity Line of Credits can have variable or fixed interest rates, but it is most common to find Home Equity Line of Credits with variable interest rates, similar to a credit card. In fact, since Home Equity Line of Credits typically come with lower interest rates than most commercially available credit cards, many consumers choose to use a Home Equity Line of Credit as a safety net instead of a credit card. In the event of a job loss or other emergency, expenses can simply be charged to the Home Equity Line of Credit.
Because the money in a Home Equity Line of Credit is usually taken out more gradually than the lump sums handed out in a Home Equity Loan, lenders are usually able to lend more with a Home Equity Line of Credit than a Home Equity Loan. In fact, some lenders will offer as much as 125% of the equity in a home on a Home Equity Line of Credit.
Both of these loans are secured against the equity in a piece of real estate, and should therefore be taken out with some caution and consideration.
The difference between a home equity line of credit and a home equity loan is in the way the loan pay outs are handled by both the lender and borrower. For the home equity loan, the usual case is that the lender will release the full amount of the loan in one payment to the borrower which the borrower pays back over a certain number of years. For the home equity line of credit however, the lender gives the borrower a kind of credit line that he can borrow on for a certain period of time, whenever the need for the money arises.
The best part about opting for a home equity line of credit is that whenever you need the money, it will be made available to you by the lender. This means that if you have an emergency, like a family member goes to a hospital and runs up a hospital bill, you can easily access you home equity lines to get the cash you need to pay the bills. Or if something happens to your home where there is extensive damage, such as a leak that destroys half your ceiling, then you can avail of your home equity line cash quickly at your convenience.
However, there are some reasons why some people would rather choose a lump sum coming from a home equity loan over home equity line of credit loans. For one thing, if you have a line of credit and you need the money, there is a minimum amount of money you have to withdraw, regardless of whether it is too much for the moment. This also entails that you have to pay specific transaction and bank fees to be able to access the amount of money that you need. Therefore, it is vital that you properly plan when you need the money and just how much you get from your home equity line of credit just so that you can prevent too many bank and transaction fees being charged.
Another downside to getting home equity lines is that although there is flexibility for you in terms of withdrawing money for your use whenever you need it, there is no flexibility when it comes to the repayment terms on the loan. Once the time period for the loan is up, it is really up. That means that you have no room to negotiate in terms of repayment terms. Instead they will pile on late fees and other penalties which will increase your debt to the lender.
Also, if you have a home and put it up as collateral for your home equity line of credit loan, you will have to realize that you are tying yourself to strict terms in handling your own home. Most lenders will limit you and prohibit you from ever renting out your home if you have a home equity line of credit loan with them. This is why it is important to always read your home equity loan terms to make sure that you are able to comply with them over the repayment period you agree to.