Differences Between a Home Equity Loan and a Line of Credit

by Barrett Barlowe, Demand Media
    Home equity loans provide funds for improvements or debt consolidation.

    Home equity loans provide funds for improvements or debt consolidation.

    You need a little extra cash to make your dream home perfect -- whether that means new flooring, or a master suite addition -- and home-equity financing is there to help. What's not to like? Dipping into the equity you have in your home gets you money lent out for better terms, and lower interest rates, than you get with unsecured loans. Borrowing against your home comes with risks, though, so do your research before you decide on a loan product -- or if you want to increase the amount of money you owe on your home.

    Basics

    The basic difference between a home-equity loan and a home-equity line of credit is that equity loans give you a lump sum of money, and a home equity line of credit provides you with a predetermined amount of credit, which you access as you need it. Home equity loans are more like traditional loans, and home-equity lines of credit more closely resemble credit cards in structure. Both use your home as collateral.

    Terms

    You start making interest and principal payments on a home equity loan as soon as you receive the money, and you keep paying until you either pay down, or pay off the loan.
    You only pay for the amount you use in a home-equity line of credit, and you either pay off, or add to the amount borrowed, up to the stated limit.

    Interest Rates

    Home-equity lines of credit usually have variable interest rates. The payments you make monthly depend on the amount of money you draw on your account, and on the current interest rate charged.

    Home-equity loans feature either fixed or variable interest rates. The prime fixed-rate products usually require good credit scores and low loan-to-value ratios. Loan-to-value ratios refer to the amount you owe on a home, as compared to its current market value. Lenders generally require loan-to-value ratios less than 80 percent for fixed-rate loans. When you have high LTV ratios, or low credit scores, your options for loan products narrow. Beware of interest-only loans, which end in you still owing a large payment at the end of the term.

    Costs/Cautions

    Prepare yourself for some upfront costs with both loan products. Credit checks, home appraisals and administrative fees add up. Rolling closing costs over into the loans only increases your debt loan on the home. You risk getting underwater on your home when you increase your debt, and property values fall. When interest rates rise, monthly payments rise too, and you might not be able to afford the increased amount. Some home-equity lines of credit impose fines for closing the line of credit before a specified time, so check paperwork carefully before you sign up. Interest from home-equity loans and lines of credit are tax deductible, but consult with a tax specialist if your have any concerns or questions.

    About the Author

    Barrett Barlowe is an award-winning writer and artist specializing in fitness, health, real estate, fine arts, and home and gardening. She is a former professional cook as well as a digital and traditional artist with many major film credits. Barlowe holds a Bachelor of Arts in English and French and a Master of Fine Arts in film animation.

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