Home Equity Loan vs. Home Equity Line of Credit
November 22, 2024
Home Equity Loan vs. Home Equity Line of Credit
If you’re a homeowner, the equity you have in your home is the difference between your home’s current value and how much you owe on it. It’s a very valuable asset. If the value of your home increases over time, and as you pay off more of your mortgage, your growing equity can be tremendously beneficial.
Your home equity is useful when you sell, providing money you could use to buy a different home or for another purpose. And it’s useful while you’re living in your home, providing money you could borrow under favorable terms, perhaps to pay for some remodeling.
A loan vs. a line
A home equity loan, also called a “second mortgage,” is often confused with a home equity line of credit (HELOC). Here’s the major distinction. A home equity loan is a sum of money that you borrow all at once and that comes with a fixed interest rate, fixed monthly payments, and a specific pay-off term—typically five to 30 years.
A home equity line of credit is somewhat similar to a credit card. If you are approved for a line of credit, you will have access to a certain amount of your home equity as needed. The interest rate is typically adjustable, with the payoff period determined by how much you borrow and the current interest rate.
A home equity loan is preferred over a HELOC when you know how much you want to borrow and want fixed payments and a known payoff date. A HELOC is preferred when you want access to money as needed.
How to qualify
When applying for a home equity loan, lenders typically require that you have 15 to 20% equity in your home. They then allow you to borrow 75 to 85% of that equity. You’ll also need proof of income and homeowners insurance, a good credit score, a history of on-time credit card or loan payments, and a low debt-to-income ratio. That last item is the percentage of your monthly gross income that goes toward debt payments. Lenders often want that figure to be around 43% or lower.
Pros and cons
A home equity loan can also be a tax-advantaged way to borrow money. At least through the end of 2025, interest on the loan is tax-deductible as long as the money is used for qualifying home renovations. Of course, the money could be used for other purposes, such as helping to pay for college or a wedding. However, in order for the interest to be tax-deductible, the money has to be used for home renovations.
The biggest watch-out with a home equity loan is that your home will serve as collateral. If you don’t repay, the lender could foreclose.
What to look for
Just as when applying for a mortgage to buy a home, it’s a good idea to shop for a home equity loan among two or three lenders, starting with one where you have an existing banking relationship. Compare their interest rates, closing costs, which could total as much as two to five percent of the loan amount, and other contract terms. Look for a loan that does not have a pre-payment penalty. That will free you to pay off the loan early if you’d like to without having to pay extra for the privilege.
As a believer, it is important to seek God’s Word and Christian counsel when making major financial decisions. While this option may not be for everyone, we hope this article helps to provide clarity on the difference between a home equity loan and a home equity line of credit.
Click here to view CCCU’s home mortgage solutions.
Matt Bell is the author of Trusted: Preparing Your Kids for a Lifetime of God-Honoring Money Management. He speaks at churches and conferences throughout the country and writes the MattAboutMoney blog.
This article should not be considered legal, tax, or financial advice. You may wish to consult a tax or financial advisor about your individual financial situation.
