Why Home Equity Line of Credit is Better Than a Home Equity Loan

Home owners have a steady and secure fall back in times of financial need. Home equity line of credit and home equity loans are sparingly regarded as secondary mortgages, since both are loans that have your house as collateral.

Caveman talk? Well, not necessarily. First, let us clear up what home equity really is. Home equity is the difference between the amount you mortgaged and the actual worth of the house. This is the basic knowledge one has to remember to fully reap the benefits of this article. Let us remember, also, that, ideally, as one is paying off his mortgage, the value of the property increases, thus increasing home equity.

Let us now discern each from the other. Both are loans that have shorter paying periods, as compared to mortgages that may reach time tables of more than 30 years, and basically cover 10 to 15 year pay periods. A home equity loan is a single loan that cannot be added upon further and have fixed monthly payments and interest rates. A home equity line of credit is a more flexible loan and works somewhat like a credit card.

At first glance, a home equity loan may seem better than a home equity line of credit or a HELOC. It appears to be a more secure bet on a starter home for a small and young family, since it offers the security of a one-time loan that presents no possibility of over-borrowing. But, on a more practical note, the HELOC is not simply an avenue to plunge into deeper debt. It allows one to borrow a predetermined amount within the life of the loan. During the said time, loans may be obtained for home improvements, emergencies, and others. Interest rates of a HELOC fluctuate, thus, creating more flexibility for the loan.

It works this way: say that you acquire a house worth $150,000 and put down a down payment of $30,000 -- your house equity is pegged at $30,000. After five years of dutiful completion of payments, you have paid off $50,000 and still owe $100,000. But the house now is worth $250,000. Subtract your balance ($100,000) from the value of the property ($250,000) and you now
have a home equity valued at $150,000. With a home equity loan, one cannot just put this equity into use, since there can only be one cash-out from the lender and everything after, concerning the borrower, will only be paying off the mortgage. But with a home equity line of credit, this increasing home equity may be used to determine the amount that can be further loaned by the borrower for his needs. The line of credit is determined by the lender, and the borrower can normally choose to pay either the principal or the interest. One can pay off the debt wholly or partially and this refreshes the credit line.

There are two divisions of time in the HELOC: the draw period and the repayment period. The draw period is the time when one can borrow against the HELOC and the repayment period is the time wherein additional debts will not be allowed and the borrower will have to pay off the loan for the rest of the life of the loan.

In comparison, a home equity loan is a stiff one-time borrowing scheme depending on the current home equity; much like the traditional collateral lending. A home equity line of credit gives one the security and flexibility, which, when one fully understands, can work positively for the borrower. One more fact that one should remember is that most of the parameters of HELOC are set by the lender, but may still be negotiated by the borrower.