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Home Equity Line of Credit vs Home Equity Loan: How to choose 01/31/2022
Have you been considering remodeling your bathroom? Do you want to add that in-ground pool to your backyard this summer or take that vacation you’ve been talking about for years?
You may be able to tap into the equity you have in your home and borrow cash with a Home Equity Line of Credit (HELOC) or a Home Equity Loan. Unlike personal consumer loans, the interest rate in these loans tends to be lower. Further, interest may be tax-deductible for home equity loans or HELOCs of $100,000 or less (check with a tax accountant for exclusions).
The Difference between a HELOC and a Home Equity Loan
A HELOC works much like a credit card but typically offers better rates. You can borrow the money as needed, up to the credit limit your lender approves. With most lenders, there is an interest-only repayment period on a HELOC (typically 10 years from when the line opens), which means that, unlike other Home Equity Loan options, you only pay interest on what you use. For example, if you use $10,000 of your line of credit, for the first 10 years after, you will only need to make payments on the interest of the loan. After the 10-year repayment period, you will start to make payments on the interest and the balance – or principal – of the loan.
With a Home Equity Loan, on the other hand, you borrow a lump sum repayable over a fixed term. This gives you the advantage of a locked-in rate but does not provide the flexible pay-as-you-go benefit of a HELOC and it does not offer the accessibility of drawing funds as you need them.
Which is right for you?
When considering a Home Equity Line of Credit vs. Loan, your reason for borrowing is a key factor. Do you have recurring expenses, such as payments to contractors during home improvements? Do you need to set aside extra funds for an emergency or unanticipated expense?
A HELOC will allow you to “pay as you go.” You will only be charged interest on amounts drawn against your credit line and you can spread out the use of your HELOC as needed, rather than borrowing the full amount. A HELOC also provides you access to cash in case of an emergency.
If you have a large, one-time expense, a Home Equity Loan may be the better choice due to its predictable payment schedule and interest rate. Keep in mind that the structure of a Home Equity Loan, like any loan, is more rigid than that of a HELOC. This can result in a “cycle of debt,” which consists of repaying the original loan only to borrow again for additional expenses once the first loan is repaid.
In addition to the typical home improvement uses for a Home Equity Line or Loan, you can use the funds for many other purposes. Whether it’s a cash safety net, college tuition, or even a dream vacation, you do not necessarily have to use the line or loan for home improvement purposes.
The above article was written by Brett Levine, Sr. Member Relations Specialist at Direct Federal. Have a question about a Home Equity Line? Brett can be reached at 781.433.2900 extension 227. You can also schedule a call with Brett by clicking here.
