As housing prices are shooting up everyday more and more people are searching for different ways to receiving low-interest financing on their home equity. Most people exploring lending options wonder what on earth is the difference between Home Equity Loan (HEL) and Home Equity Line of Credit (HELOC).
Before outlining the major difference between the HEL and HELOC lets understand what they actually are in the first place.
In a simplest definition Home Equity Loan or HEL is a way of borrowing money against your home in one lump sum payment usually with fixed interest rate. Sometimes people go with Home Equity Loan (HEL) option to refinance or consolidate certain debts such as auto loans, credit cards payments or to obtain finance to repair or renovate home etc. The criteria that defines maximum amount that you can borrow depends on some key factors such as loan to value ratio, your credit history, your level of verifiable income and payment terms. In addition to fixed interest rates, Home Equity Loan (HEL) typically have fixed term and fixed monthly payment. Paying off other debts with HEL also benefits you with lower payments, lower interest rates and 100% tax deductibility. Please seek advise from your accountant or tax adviser to see if you qualify.
Unlike HEL, a Home Equity Line of Credit or HELOC is a kind of revolving credit that you can borrow against your home as collateral. Unlike HEL, you can draw the money multiple times from the pre-decided pool of money available for borrowing and utilize it for any purpose you like. Home Equity Line of Credit (HELOC) has variable or adjustable interest rate. The total amount you can borrow depends on appraised value of your home, your credit history, other debts and your verifiable income. Accessing the money from these loans is as simple as writing a check or in some cases using a debit card that makes it handy to pay for routine expenses such as tuition fees or remodeling projects. It is always advisable to monitor and control your spending because if you are unable to make your payments in time, your home is always on the line.
The two major difference are the interest rates and the repayment terms. As discussed, Home Equity Loan (HEL) has fixed interest rate with fixed monthly payment terms whereas Home Equity Line of Credit (HELOC) has adjustable or variable interest rate with similar same monthly payment terms but usually with variable monthly interest rates. With fixed interest rate, the borrower has to pay the same amount on the loan each month. If it is variable interest rate then the borrower has to pay the fluctuated interest rate. This fluctuation is usually based on a publicly available index eg. Prime Rate or US Treasury Bill rate.
Mode and method of payment is also another significant difference between HEL and HELOC. Home Equity Loans (HELs) are paid as fixed monthly payments that include both principal plus the interest amounts. Some lenders accept large sums of payments if you wish to pay off your loan quickly whereas some other do not like it and charge you penalty for early payments. In the case of Home Equity Line of Credits (HELOCs) the mode of payment works the same way except the monthly interest payment rate may fluctuate with public index. Some lenders like balloon payments practices where they want you to only pay the monthly interest amount during draw period and settle the whole amount at the end of draw period.
Always check the repayment terms with your lender before hand very carefully. If you are struggling with the payment of your mortgage, an expert housing counselor can help you with better financial options that make more sense to you.