Guest posting on the personal finance blog Budgets Are Sexy, Robert Sommers explains the difference between home equity lines of credit and home equity loans, which are also known as second mortgages.
If you already knew the difference before reading the post, you’re more savvy than I, who thought they were different names for the same thing. Not so, Sommers explains:
Home Equity Line of Credit, or HELOC, also allows a homeowner to borrow against the value of their home. The loan is essentially a form of revolving credit in which your home serves as collateral. There are two major differences between this type of loan and a standard HEL. First, a HELOC typically has a variable interest rate rather than a fixed one, meaning that the amount of your monthly interest changes just as it would for an adjustable rate mortgage. The second difference is that rather than receiving the entire amount as a lump sum at the start of the loan, the borrower is given a predetermined line of revolving credit that has a draw period of 5-25 years during which funds can be drawn whenever needed.
There is a maximum limit that can be taken out and a minimum payment that is due each month, with the borrower given the option to pay off as much of the line as he and/or she wants- much in the same way as you would with a credit card or other revolving line of credit. A big advantage that comes with a HELOC is that the borrower pays interest only on the money that they draw, rather than the entire sum as they would with a Home Equity Loan.
Sommers says HELs are better if you’re using the money for set expenses, while HELOCs make more sense if the amount of extra money you’ll be needing varies.
It’s definitely best to avoid either unless absolutely necessary, because both can be gateway drugs to bankruptcy.