What Is the Difference Between a Home Equity Loan & a Home Equity Line of Credit?

Equity is the difference between the value of your property and how much you owe on your mortgage. When you need to access the equity in your home, one option is to take out a second mortgage. Home-equity loans and home-equity lines of credit (HELOCs) are both types of second mortgages that can be used to get you the cash you need.

The Facts

A home-equity loan is a second mortgage that gives you a lump sum of money based on the amount of equity you have. For example, if your property value is $200,000 and you owe $100,000 on your mortgage, you have $100,000 in equity that you can access. A home-equity line of credit is also a second mortgage, but this loan against your equity is set up much like a credit card in that you can use a predetermined amount of money on an as-needed basis.

Function

The interest paid on either a home-equity loan or a HELOC is tax-deductible, and both are easily accessed and don't cost much to process. The decision of which one is right for you depends on how you need to use the funds. With a home-equity loan, the entire loan amount is taken out in a lump sum, and you can make a large purchase, consolidate high-rate credit card debt, take a vacation or anything else you might need a large amount of money to do. Your monthly payment and interest rate will be fixed for five to 15 years, depending on the term of the loan. In contrast, you use a HELOC only as you need it. Payments are based only on the amount used, rather than on the entire line of credit, and the interest rate is variable, meaning it fluctuates as the index it's tied to goes up and down.

Effects

A homeowner who takes out a home-equity loan or a HELOC as a second mortgage is committing to two monthly payments: the payment on his existing first mortgage and the new second mortgage payment. If you're considering a sizable home-equity loan or a HELOC, keep in mind that your payment can be sizable as well. If the loan is used to consolidate high-rate credit card debt, you might find that your total monthly payment amount will decrease, and this will increase your credit score even though your overall debt level remains about the same.

Considerations

You can use as much of a HELOC as you need, up to 100 percent of the balance, pay the balance down and continue to keep it open, using it as needed. However, this option is not possible with a home-equity loan. When you get the loan, the funds are disbursed at once, and you make payments on it until it is paid off. Paying the balance down does not allow use of it again.

Warning

A HELOC may require a random credit check to keep the account open, and the interest rate can fluctuate as its index changes, possibly increasing your minimum payment. This type of loan typically allows for interest-only payments, but if interest is all you pay, the credit line never gets paid down and you have little or no equity in your home.