A home equity line of credit (HELOC) and a home equity loan (HELOAN) both allow homeowners to borrow against the equity they’ve built up in their home, but they function in different ways:
1. Home Equity Line of Credit (HELOC)
- Structure: Works like a credit card. It’s a revolving line of credit with a limit based on the homeowner’s equity.
- Interest: Variable interest rates, which means the rate can change over time depending on market conditions typically tied to the Prime Rate Index.
- Repayment: During the “draw period” (typically 5-10 years), you can borrow as much or as little as you need, and you’re only required to pay interest on what you borrow. After the draw period, you enter a “repayment period” (usually 10-20 years) where you repay both principal and interest.
- Flexibility: You can borrow money multiple times as long as you’re within your credit limit, which gives flexibility to access funds as needed.
2. Home Equity Loan (HELOAN)
- Structure: Functions like a traditional loan. You receive a lump sum upfront and repay it in fixed installments.
- Interest: Typically has a fixed interest rate, so your payments are predictable over the loan term.
- Repayment: You start repaying both the principal and interest immediately after receiving the loan. The repayment period is often 5-30 years.
- One-time Loan: You receive the funds all at once, and there is no option to borrow more later unless you take out another loan.
Key Differences:
- Flexibility: HELOC offers ongoing access to funds (like a credit card), while a home equity loan gives a one-time lump sum.
- Interest Rates: HELOCs usually have variable rates; home equity loans often have fixed rates.
- Payment Structure: HELOC has an interest-only payment period before requiring full repayment, whereas a home equity loan requires immediate principal and interest payments.
The choice between the two depends on your financial needs—HELOCs work well for ongoing expenses, while home equity loans suit one-time large expenses. One can have rates over the other, depending on the current rate environment.