Cash-out refinancing used to be the most popular way to turn home equity into cash but rising mortgage rates have pushed these products out of the spotlight. As homeowners look for alternative means to access the equity in their homes, home equity loans and home equity lines of credit are poised to make a comeback.

Both home equity loans and home equity lines of credit are types of second mortgages, a loan that allows homeowners to maintain the low interest rate on their primary mortgage while using the equity in their home as collateral. While both serve as low-cost financing options, there are distinct differences between the two home equity loans.

What is a home equity line of credit (HELOC)?

A home equity line of credit, or HELOC, is a revolving line of credit that works much like a credit card but with a substantially lower interest rate. You can continuously borrow against the line of credit, using as much or as little as you want, and pay interest only on what you borrow.

A HELOC has two distinct phases: the draw period and the repayment period. The draw period, during which you can withdraw funds, might last 10 years, and the repayment period, during which the loan converts to a repayment schedule, might last another 20 years, making the HELOC a 30-year loan. Because you’re only charged for your outstanding balance at the end of the draw period, your monthly repayment amount will largely depend on how much you’ve borrowed.

Similar to a credit card, how you use the home equity line of credit is up to you. However, because a HELOC allows for accessing large amounts of money over time as needed, it can be especially useful for costly, long-term projects, such as home remodeling, renovations, and additions.

PROS OF A HELOC

• • Borrow up to 95% of your home’s equity
  • Pay interest only on the amount you draw
  • Flexible credit line for ongoing expenses
  • Lower interest rates compared to credit cards and personal loans
  • Interest payments may be tax-deductible
  • Higher credit limits than credit cards and personal loans
  • Money can be used for any reason

CONS OF A HELOC

• • Money can be used for any reason
  • Your home serves as collateral for the loan
  • There is a set draw period
  • Variable interest rates mean your costs could rise
  • Possibility of overspending

What is a home equity loan (HELOAN)?

A home equity loan, or HELOAN, is a fixed-rate loan that is more akin to a primary home mortgage than a HELOC. Unlike a home equity line of credit, a home equity loan is dispersed in one lump sum and paid back in fixed monthly installments.

Since it’s a lump sum equity draw, a home equity loan is a good source of money for large projects and one-time expenses, such as a wedding, the purchase of a second home, or debt consolidation.

Pros of a HELOAN

• • • Borrow up to 95% of your home’s equity
    • Lower interest rates compared to credit cards and personal loans
    • Receive a lump sum payment at a fixed interest rate
    • Fixed monthly payments
    • Interest payments may be tax-deductible
    • Money can be used for any reason

CONS of a HELOAN

• • • Your home serves as collateral for the loan
    • You could pay higher rates than you would for a HELOC (fixed vs. variable)
    • Possibility of overspending
    • Can’t take out more for an emergency without another loan

HELOCs and HELOANs are similar in that you’re borrowing against your home equity. But a home equity line of credit is like a credit card, while a home equity loan gives you a lump sum of money all at once. Before deciding whether to apply for a HELOC or a HELOAN, consider how much money you need and how you plan to use it.

At a time when home equity is rising rapidly, it may be worth considering what a second mortgage can do for you. Give Loan Pronto a call if you’re ready to learn more about the home equity and refinancing options available to you.

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