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Home Equity Loan Or Home Equity Line Of Credit: Which Is Best?
By EchoBay Loans Staff Writer

You've decided to get a loan for that new kitchen or to pay off credit card debt but which type of loan is financially the right decision? Which will cost the least in monthly payments, a home equity loan (HEL) or a home equity line of credit (HELOC)? The answer won't be the same for every borrower but there are guidelines and advice that can help you choose the type of home equity loan that saves the most money.

Loan Comparison: Home Equity Loan vs. Home Equity Line of Credit

The first and largest difference is how the loans are paid off. A home equity loan is a lump sum of money that is borrowed and paid off over a fixed amount of time usually at a fixed interest rate with monthly loan payments that do not change month to month. For a home equity line of credit, a borrower is approved to borrow a certain amount of money based upon the amount of equity in a home, and the homeowner can borrow from this credit line over a pre-determined period of time.

A home equity line of credit is similar to borrowing using a credit card with the difference being the homeowner's house is pledged as collateral. The money borrowed from the line of credit can be increased or decreased over the term of the loan depending on how much money is needed at any time during the loans life. Both of these loan types differ from mortgage refinancing in that when you refinance a home loan, it remains a first mortgage, unlike home equity loans which are considered a second mortgage.

The second difference between the these two loans is the type of interest rate each has. A home equity loan, such as a 100% LTV fixed rate home equity loan, uses a fixed interest rate that will not change over the life of the loan. This feature is desirable by homeowners who want the security of a loan rate that can't change, making for monthly loan payments that can be budgeted.

Home equity credit lines have variable interest rates that are adjusted by a bank or home equity lender when the Prime Rate changes. The rate is calculated as Prime Rate plus an additional rate of interest. A home equity loan rate for a line of credit will have a lifetime cap as to the maximum rate of interest that can be charged in any billing period.

Third, the length of each type of home equity loan can be different. Home equity loans generally have a longer loan term between 15 and 20 years. A 125% loan is generally 15 years. This makes these types of loans closer to a regular mortgage loan. A home equity line of credit generally is for a shorter period between 5 and 10 years

The fourth difference is in the ability to borrow additional funds against the loan. A home equity loan is a loan for a single amount of money. If a homeowner were to borrow $50,000, then a new loan would need to be approved in the future if a homeowner needed to finance more than this. If this same homeowner was approved for a home equity credit line they could borrow different amounts of money as needed throughout the loans life, or "draw period". A borrower may need to maintain a certain outstanding loan balance called a "minimum draw" during the life of the loan.


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