Home equity line of credit or a home equity loan: Which is right for you?

If you're a homeowner, you can borrow against the value of your house through either a home equity line of credit (often called a HELOC or a line) or a home equity loan (often called a HEL or loan). Both are essentially a second mortgage.

What's the difference?

A HELOC is a form of revolving credit similar to a credit card. It allows you to draw funds, up to a predetermined limit, whenever you need money. There is generally a minimum payment due each month, with the option to pay off as much of the line as you want. With a HEL, you receive a lump sum of money and have a fixed monthly payment that you pay off over a predetermined time period. In each case, the amount you can borrow is based on factors such as your income, debts, the value of your home, how much you still owe on your mortgage and your credit history.

Benefits

The appeal of both of these types of loans is their interest rates, which are almost always lower than those of credit cards or conventional bank loans because they are secured against your home. In addition, the interest you pay on a home equity line or loan is often tax deductible (consult a tax advisor about your particular situation).

Which is best for you?

Generally, a HELOC is a good choice to meet ongoing cash needs, such as college tuition payments or medical bills. A HEL is more suitable when you need money for a specific, one-time purpose, such as buying a car or a major renovation.

Comparing the costs

Both HELOCs and HELs usually carry a higher interest rate than that of a first mortgage. With a HEL, you may choose either an adjustable rate that fluctuates according to variations in the prime rate, or you may opt for a fixed rate. A fixed rate enables you to budget a set payment monthly without worrying about increasing costs should interest rates rise. With a HEL, there are also closing costs that you should consider.
A HELOC usually carries a lower initial interest rate than a HEL, but its rate fluctuates according to the prime rate, so there is more interest rate risk. Unlike a HEL, where your monthly payments are a set amount, a HELOC enables you to borrow funds as needed and repay as little as interest only each month. In addition, there are generally no closing costs when you open a HELOC.
Keep in mind, your home is the collateral for both a HELOC and a HEL. If a HELOC's easy access to cash tempts you to run up more debt than you can repay, or if you fail to make your payments, you risk losing your house.

	Home Equity Line of Credit (HELOC)	Home Equity Loan (HEL)
What you get	Revolving credit, with a specific credit limit of up to 100 percent of the value of your home (its value minus all debts against it). Some lenders will allow you to borrow up to 125 percent of the value of your home.	A fixed amount of money, up to 100 percent of your equity in your home (its value minus your first mortgage debt and other debts). Some lenders will allow you to borrow up to 125 percent of the value of your home.
How to qualify	You typically need to provide proof of your income, home ownership, your mortgage and how much equity you have in your home. An appraisal is usually required as well.	You typically need to provide proof of your income and home ownership, and proof that at least 20 percent of the value of your home is paid off. An appraisal is usually required as well.
How you repay it	Minimum payments (as little as interest only) each month; eventually you have to repay the entire sum borrowed plus interest.	Fixed payments of interest and principal over a fixed period of time.
How long it lasts	You have a 10- to 20-year period when you can draw on the line (up to the credit limit), after which you have a fixed period to pay off the outstanding balance plus interest.	The term of the mortgage can be as short as a year or as long as 30 years.
Costs and fees	Usually no closing costs, but may have an annual fee.	Closing costs that are lower than for a first mortgage.
How you receive the money	You draw funds as needed, using special checks or a credit card.	You receive one up-front lump sum.
Interest rate	The prime interest rate plus a margin (which can vary from one institution to another).	A fixed or adjustable interest rate.
Tax status	Interest may be tax-deductible (consult a tax advisor).	Interest may be tax-deductible (consult a tax advisor).