Home Equity Loan or Line of Credit: What is the Difference?

Dated: 09/14/2018

Views: 1

Home Equity Loan or Line of Credit: What is the Difference?

The equity in your home is an untapped resource for financing such things as remodeling projects or a child’s college education. Is it wise to take a home equity loan or a line of credit, and how do they work?

The equity in your home — the value of your home minus what you owe — is not liquid. It can only be used by borrowing against the house via a formal agreement with a bank or other lending institution. Most financial planners advise homeowners to use a home’s equity only for investing back into the house but borrowers may use the money as they wish.  Financial advisers strongly discourage using the money for short-term expenses and certainly not for consumer spending such as vacations or depreciating assets like boats, vehicles or electronics.

General terms. State laws restrict borrowing. Your state, for example, may allow you to borrow an amount equal to 80 percent of the current appraised value of the house, minus what you owe on it. Assume, for illustration, the house appraises today at $200,000 and you owe $110,000 on it. You would have $50,000 available to you, since 80 percent of $200,000 equals $160,000 minus the $110,000 owed.

These lending standards would apply to either a home equity loan or line of credit. With both products a second lien is placed on the property. Essentially the lender is advancing the money tied up in your home, collateralized by the house. This means the lender can foreclose for default. Both types will have a loan application and closing process similar to a first mortgage. The interest paid on both types is tax deductible.

A line of credit. A home equity line of credit secures you the dollar amount available for use. You do not have to borrow the entire amount. For example you may have $50,000 available to you and only tap into $24,000 for a kitchen makeover. You will have a limited amount of time to use the balance, known as the draw period. As you pay back principal on a home equity line of credit, the amount repaid becomes available again.

The interest rate on a line of credit usually is variable, such as the prime lending rate plus two percentage points, fluctuating while money is owed. This can be a problem when rates rise. You may have the option of making interest only payments.

An equity loan. With a home equity loan, the equity is drawn out of your home in a lump sum, rather than drawing it out piecemeal as needed.

Terms vary by state lending laws. Each state has its own laws dictating what can be offered to consumers. Check with lenders in your area for specifics.

Blog author image

Nara Rakhmetova, MBA

My name is Nara Rakhmetova, I am a full time real estate consultant, specializing in Northern VA area. I love my job and take every client's real estate needs personally. Many clients I helped in the ....

Latest Blog Posts

Latest Weekly Lorton Real Estate Transactions

Be sure to bookmark this page in order to see all the latest Real Estate Transactions occuring in Lorton. Bonus Links:All Properties Currently For Sale in LortonLorton Market Activity and

Read More

Lorton VA Real Estate Transactions

Be sure to bookmark this page in order to see all the latest Real Estate Transactions occuring in Lorton. Bonus Links:All Properties Currently For Sale in LortonLorton Market Activity and

Read More

Floor Plans: Choosing the Right One for You

Touring model homes is one of the best ways to get a feel for whether a floor plan will work for you. It’s time well spent before committing to such a huge investment in your future. Take your

Read More