Home Equity Loan & Line of Credit Comparison

Installment Loan and Credit Line Both Use House as Collateral

Jun 16, 2009

Home equity installment loans and home equity lines of credit both rely on the value of a house as collateral, but are suited to different circumstances and borrowers.

Home equity loans make it possible for homeowners to use the capital they have invested in their home by borrowing against their house's value – a convenient way to pay for home renovations, a child's education, a big wedding, or other expenses without refinancing a mortgage. There are two types of home equity loans, each with their own advantages and disadvantages.

How Home Equity Loans Work

A home equity loan is secured against the equity in a home. This means that if a borrower defaults on the loan, the bank or lender can seize the house to recoup their losses. Because the loan is secured and banks stand to lose very little, it also means that they can offer a bigger loan (up to 90% of existing home equity) at lower interest rates than they might have if the loan were unsecured.

Home equity loans are a great way for homeowners to use the money they have invested in their house without paying the fees required to refinance a mortgage – but it still may not be the best idea for every financial need.

There are two types of home equity loans: home equity lines of credit, and home equity installment loans. Finding the best fit will depend on the amount of money to be borrowed and how it will be used.

Home Equity Lines of Credit

A home equity line of credit (or "HELOC") works like a cross between a bank account and a credit card. It has a maximum limit – usually 75-90% of the equity in a person's home – and can be drawn on as needed. Only interest has to be paid until the loan comes due (usually 5-25 years), at which time the loan must be paid back in full.

Home Equity Installment Loans

A home equity installment loan (or "HEL") operates more like a standard loan. It is a one time loan that is paid back in installments. These are usually monthly payments that include both interest and principal. The loan may be amortized over 3-30 years.

Pros and Cons of Each Type Home Equity Loan

Home equity loans and home equity lines of credit each have advantages and disadvantages. Choosing the best one will usually depend on the circumstances for which the loan is intended.

A home equity installment loan is ideal for someone purchasing a car, paying for home renovations, or financing a one time investment or purchase. The loan can be repaid over time on a regular schedule, and since HELs normally accrue interest on a fixed rate, a borrower can lock in a low interest rate against any changes in the market.

Home equity lines of credit, on the other hand, are best if expenses will be staggered over time – like a child's college tuition, medical bills, to cover expenses in a short period between work, or for anything else you might use a credit card to pay.

A home equity line of credit has a much lower interest rate than a credit card, but it is paid off in a similar way: only interest is due monthly, and the remainder of the debt can be paid off at will. Unlike a credit card, however, a line of credit will come due at a predetermined time and must then be paid in full – so it should not be relied on as an indefinite source of revolving credit.

Home equity lines of credit usually have lower initial rates than home equity installment loans – but that rate can fluctuate with the market. The interest rate of a HEL is fixed, whereas a HELOC's rate is usually variable. This may be a decisive factor for some borrowers who are risk intolerant or who wish to secure a low interest rate.

The choice between a home equity line of credit and a home equity loan is usually based on the use to which the money will be put, with some element of personal choice and the current interest rates as an additional factor.

Sources

The copyright of the article Home Equity Loan & Line of Credit Comparison in Personal Loans is owned by Victoria Anisman-Reiner. Permission to republish Home Equity Loan & Line of Credit Comparison in print or online must be granted by the author in writing.