By MyBankTracker  Fri Aug 21, 2009

HELOCs Vs. Home Equity Loans: Which Option Is Right For You?

From time to time, households or individuals would need to shoulder some major expenditures that are not included in the monthly budget. These could include medical bills, home renovations, cars, and college education costs, among others. Some don’t want to touch whatever savings they have in the bank while others don’t have any cash at all. In both cases, the most obvious option left is to take a loan or some form of credit.

calculating_heloc

If you are a homeowner, tapping into your home equity is one of the first sources that you should look into, as most home borrowings carry lower interest rates than credit cards and other loans, and the interest payments are tax deductible. So the question now is: which is the best type of home loan for your needs?

In this article, we are evaluating two of the more common options available these days – HELOCs or the home equity line of credit and home equity loans. Here are the main similarities and differences between these two:

Loan Type

Features

Collateral

Loan Proceeds

Interest Rate

Payment Terms

Upfront Fees

HELOC

Home Equity

Revolving Credit Line

Variable, dependent on the prime rate

Flexible

Lower or no upfront closing fees

Home Equity Loan

Home Equity

Outright Cash

Fixed

Fixed

Up to 2%-5% of the loan value

Let’s go into more detail on the salient features of these loans so that you would have a clearer idea of what alternative is more suited to your needs, regular budget, and your present and future financial resources.

Loan Proceeds

The HELOC and home equity loan differ greatly in terms of how the loan is made available to the borrower. The former is a credit line where you can draw from should the need arise using debit cards, credit cards, or checks, while the latter gives you an outright sum upon closing of the loan.

The HELOC therefore is a form of standby resource and would be a good option to take when you are still anticipating the need such as possible unemployment, major medical treatments, or when you won’t immediately need as much as the value of your home equity. The home equity loan on the other hand, can be used in just about any situation where you would need a large sum of money.

Interest Rate and Payment Terms

The interest rate is also an essential factor to consider when making a choice between these two. While they both come with some of the lowest rates around, the HELOC’s variable rate is tied to the prime rate for that particular period, while the home equity loan has a fixed rate for the entire life of the loan.

Because of the difference in the interest rate factor, the repayment terms also vary greatly. With the HELOC, you are given the option to pay the interest only on certain months, and pay up the principal amount or whatever amount you used, at the end of the term (usually after 5 or 7 years). The home equity however, requires you a fixed monthly payment for the duration of the loan, much like the monthly amortization on your original home mortgage.

If don’t want to be caught off guard with sudden rise in interest rates and want to slowly pay off not only the interest but also part of the principal loan, then the home equity loan is a better fit for you. And then again, if you want the flexibility of lower monthly payments at times when the budget is constrained, then the HELOC can give you just that.

Closing and Maintenance Fees

There are a lot of lenders that now offer no-cost options for the HELOC. In much the same way as a credit card does however, it charges an annual fee of about $50 – $100. You also have too look out for banks or creditors that charge a “no usage” fee for home equity lines that remain unused and are primarily made into “reserve” accounts by the homeowners.

In contrast to the HELOC, home equity loans cost a lot upfront. In fact, the fees charged are similar to those when availing of a home mortgage, and could run into thousands, depending on the loan amount.

Would you rather go for standby credit or outright cash? Is paying interest-only payments easier for you than fixed monthly amortizations?  Are regular annual fees more affordable than higher upfront costs? Ultimately, the choice is yours. Consider all the above factors carefully before making your decision.

Home-Equity

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