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Home Equity Loans vs Home Equity Lines of Credit

Home equity lines of credit and home equity loans are technically second mortgages since they need to be paid back. This article is meant to show the similarities, differences, the practical applications, and the pros and cons of home equity lines of credit (HELOC) weighed against those of home equity loans.

The qualities that home equity lines of credit (HELOC) and home equity loans share are: 

  1. They are both tax deductible for amounts of up to $100,000.
  2. They have shorter loan periods than do standard mortgages (5 to 15 years).

HELOC: Strengths & Weaknesses

A home equity line of credit (HELOC) allows you to use the equity in your home like a credit card and withdraw hard cash whenever you need it. The rates associated with an HELOC are adjustable and initially lower than that of home equity loans. For this reason, financial experts say that having your income deposited with your HELOC makes more sense than having it deposited in your credit card account. Financial analysts advise homeowners to put all of their income in their HELOC because it is "open-ended". This means that building your home equity benefits you on two fronts: It keeps your mortgage in better shape when it is unused on one end, and you can use the cash whenever you need it on the other end. You can accelerate the paying of your mortgage up to three-times faster than with any other strategy.

One important drawback with HELOCs is that homeowners often abuse their access to easy money without discipline for short-term relief. 

Another catch with an HELOC is that it is available predominantly with adjustable rates. The risk involved then could turn the advantage you reap from an HELOC upside down on its head - if interest rates rise, your monthly payments will increase and you could suffer huge losses with more debt than what you started with. There are fixed-rate variants of HELOCs but their interest costs are slightly higher.

Another drawback with home equity lines of credit is that they can be very expensive in the long run. Interest-only options for an HELOC could make paying your loan difficult because interest-only means that no payments are covering the principal. This could eventually result in a single balloon payment due to your unpaid principal, and make it difficult to recover.

Home Equity Loans: Pros & Cons

This brings us then to home equity loans. This loan is ideal for a one-time major event like a wedding since you can only use it once. The lump sum form of the loan qualifies it as a second mortgage more strongly than an HELOC. The rates are higher than that of a home equity line of credit to cover the costs of secure interest rates. 

The benefits of home equity loans

  • Predictable monthly payments: Combined with the short loan term (5 - 15 years), predictable monthly payments can make it extremely easy to guarantee the stability and success of the loan.
  • Easier to budget for: Knowing exactly what you're going to pay every month of every year of the loan will make your financial planning simple and straightforward.
  • Ideal for homeowners that lack discipline: Even if you blow it all on meaningless activity, you're effectively blocked from using it again and risking your financial stability.

The drawbacks of home equity loans

In the case of responsible homeowners, a one-time-only lump sum can be very limiting to building wealth, especially when the higher interest costs associated with fixed rates which could effectively limit them even further. More restrictive still are the fixed rates that stay afloat when adjustable rates drop for everybody else.

The differences between an HELOC and a home equity loan in practice also lie in their use. If, for example, you had two more payments left to cover the loan on a car, and you know beforehand the cost of your upcoming honeymoon, a home equity loan will make more sense since you know when and what these will cost you. However, scheduled college fees that surmount on a regular basis are better handled with a home equity line of credit.

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