You’ve seen the terms home equity loan or home equity line of credit thrown around, in a seemingly interchangeable way. But they’re not the same! Before we dive into which financial product might be right for you, let’s define the terms.
A home equity loan (HELOAN), or second mortgage …
… uses the equity in your home as collateral and allows you to borrow against the value you have in your home, based on factors like your home’s current value and your mortgage balance. Just like a conventional mortgage, home equity loans have a repayment term, typically 5-20 years, where you make fixed payments each month. Home equity loans can be useful for responsible borrowers who want to make renovations to their home, finance short-term education expenses, or for debt consolidation.
In contrast, a home equity line of credit (HELOC) …
… is a loan that’s set up as a line of credit, can be drawn from up to a certain dollar amount, has a “draw period” during which you can use it like a checking account (usually 10 years), followed by a repayment period (usually 10-20 years). HELOCs are simple interest loans where interest is calculated on a daily basis and is based only on what you owe vs. a HELOAN, where it’s amortized – likely costing you more in interest. This approach helps you reduce your principal balance and reduce the amount of interest you’re paying – meaning you pay less interest to the bank over time. The primary reasons for a first lien HELOC include quickly paying off your mortgage, saving for educational expenses, and building wealth.
So, what’s better? A HELOAN or HELOC?
Before you decide which financial product – a home equity loan or home equity line of credit – is right for you, it’s important to understand your goals and how you plan to use this money. Remember, both of these approaches use your home as collateral for the loan. If you’re looking to redo a master bathroom or make updates to the exterior of your home, a home equity loan may be simpler and more beneficial. For example, home improvements that will cost less than $20,000 are ideal for home equity loans.
If your goal is to pay down your mortgage faster, increase your financial security, or save money for retirement, then a first position HELOC may be the best choice – if you have positive cash flow. Simply put, using a home equity line of credit to pay down your mortgage may help reduce the time it takes to pay off your home, freeing up money that can help you live a life of financial freedom.
To learn more about this simple but powerful financial strategy that can put your entire income to work for you with a home equity line of credit, visit our FAQ page or download our free resource guide, Take Control of Your Equity.