A Home Equity Loan vs. A Home Equity Line of Credit

What’s the difference between a home equity loan and a home equity line of credit?

It’s a good, important question. With the help of Don Taylor, a certified financial advisor, allow us to provide the answer:

A home equity loan comes equipped with a fixed interest rate, along with monthly payments sized to pay off the loan over its term. You receive the entire loan amount as a lump sum when you close on it.

In contrast, a home equity line of credit (HELOC), is an adjustable-rate loan, with changes in the interest rate typically tied to changes in the prime rate, which is itself tied to changes in the targeted federal funds rate. The Federal Reserve Board’s Open Market Committee meets eight times per year to discuss the economy and decide whether to change this targeted federal funds rate.

Other differences: Besides possessing a variable interest rate, a HELOC has interest-only payments, at least in the early years of the loan. Some HELOCs are structured to have interest-only payments over the entire loan term, with a balloon payment at the end of the loan. Other HELOCs become self-amortizing loans after an initial period of interest-only payments.

It varies.

Because this is a line of credit, you only borrow what you need, although there may be a minimum draw against the line when you close on the loan. At least for part of the loan term, the credit line is a revolving credit; paying down the balance frees up credit capacity.

The changes in the federal funds rate over the past 2½ years have caused the interest rates on HELOCs to rise above the fixed rate of a home equity loan. Of course, this doesn’t mean that the loan is necessarily the better choice.

What do you plan on doing with the money? How will you manage the monthly payments? Where will interest rates be headed in the future? These are important questions to consider as you weigh various home loan options.