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Key Differences Between a Home Equity Loan vs Line of Credit

Home equity loans and home equity lines of credit (HELOCs) both allow homeowners to finance a percentage of their home’s equity. While both options can help homeowners gain access to additional funding, there are key differences between home equity loans and HELOCs that borrowers should be aware of.
HELOC interest rates

Home equity financing can be used to help homeowners renovate their current property or pay off large sums of debt. Home equity loans and home equity lines of credit are often referred to interchangeably but are not the same thing.

Understanding the differences between these two types of home equity financing can help you choose the best option for your financial situation.

Home Equity Loans vs. Home Equity Lines of Credit

Both home equity loans and home equity lines of credit (HELOCs) are financing options based on the value of your home. Also known as a second mortgage, the amount homeowners can borrow is based on the value of their home minus the amount remaining on the mortgage.

To calculate your home’s equity, you would subtract the amount remaining on the mortgage from your home’s value.

So, if the value of your home is $300,000 and you have $100,000 remaining on the mortgage, your loan will grant you approximately $170,000 in financing ([$300,000 - $100,000] x .85).

Generally, both home equity loans and HELOCs offer buyers up to 85% of this value.

Both financing options work a little differently, though. Here’s a quick breakdown of the differences between the two.

Home Equity Loans

A home equity loan is a lump sum of money given to a borrower at one time, generally with a fixed interest rate. This means that borrowers receive all funds in one lump sum once the loan is processed, allowing them to pay for renovations, pay down debt, or use the money however they see fit.

Pros:

  • You receive all funds at one time
  • Fixed-interest rate means monthly payments are predictable
  • No additional annual fees
  • Lower interest rates than private loans
  • Funds can be used for whatever you need

Cons:

  • Higher interest rates than HELOCs
  • Your home is collateral; if you default your home could be in jeopardy
  • Buyers pay closing costs and other fees

Home Equity Lines of Credit

A HELOC, however, is dispersed differently than a home equity loan. Similar to credit cards, HELOCs allow borrowers to withdraw multiple times for a revolving line of credit over a certain time period. Interest rates for HELOCs are generally variable, and not fixed.

Pros:

  • Only use what you need, when you need it
  • Interest and payments do not begin until you access your funds
  • Lower interest rates than private loans and home equity loans
  • Low (or no) fees
  • Fast approval process

Cons:

  • No payment predictability due to adjustable rates
  • Your home is collateral; if you default your home could be in jeopardy
  • If your home’s value declines, the lender can freeze or reduce your line of available credit
  • Most lenders charge annual fees
  • Many lenders charge penalties for prepayment, inactivity, or cancellation

Which Home Equity Financing Option is Right for Me?

Both home equity loans and HELOCs can be great ways for homeowners to gain access to additional funding. If you need the entire value of your home’s equity quickly, a home equity loan might be a better option. However, if you’re renovating or simply need access to funding to finance a large project, a HELOC may be a better fit.

It’s also important to note that if you use your home equity funding to improve your residence, you can deduct the loan interest on your taxes. If the loan is used to fund anything other than your residential property, it cannot be deducted,

Using Home Equity Financing for Investment Properties

Another way home equity financing is often used is to fund investment properties. Many homeowners will take out a home equity loan or line of credit in order to cover the down payment, closing costs, and renovation of a rental property.

Many beginning investors fund their rental properties through home equity financing and pay off the balance over time using their additional rental income. Home equity loans and lines of credit can be excellent methods for new investors to build or scale their real estate portfolio.

If you use your home equity loan or HELOC to fund an investment property, you cannot deduct the interest paid on your taxes, since the property is not your primary residence.

Review

Home equity loans and HELOCs provide homeowners with great options for gaining access to financing at low rates. While both financing options have pros and cons, home equity loans can be better for homeowners who need a large sum of money quickly, while lines of credit might be more beneficial for someone needing access to funds over a longer period of time.

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Jamie Ayers
Jamie Ayers

Jamie is the Director of Content at Clever Real Estate, the free online service that connects you with top real estate agents and helps you save thousands on commission. In the past, Jamie has managed columns for clients in a variety of leading business publications, including Forbes, Inc., CEO World, Entrepreneur, and more. At Clever, Jamie's primary goal is to provide home sellers, buyers, and investors with the information they need to successfully navigate the ins and outs of the real estate industry.

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