Home Equity Loan Vs. Home Equity Line of Credit: What’s the Difference?

Did you know that you can borrow money against the equity you’ve got built up in your home?

If you’re a homeowner and have accrued equity as a result of appreciation, a long string of payments, or both, you may be able to take advantage of certain loan types to gain access to lots of cash to cover a pressing expense.

Whether you want to renovate your home, pay for your child’s college tuition, or just go on a big family vacation, you can access that money from your home’s equity if you don’t have enough cash in the bank.

Two of these specialized loan types are home equity loans and home equity lines of credit (HELOC). The question is, what’s the difference between the two?

What’s a Home Equity Loan?

A home equity loan allows you to borrow against the equity in your home. It’s a type of second mortgage that can provide you with access to a lump sum of money and is usually a bit easier to qualify for compared to other loan types simply because it’s secured by collateral: your home.

Your home must be worth more than what you owe on it in order to be eligible. If you qualify, you can use the money for whatever you need it for. That said, you will need to make sure that you’re financially capable and responsible enough to make the payments on time every month. If you don’t, you stand to lose your home.

What’s a Home Equity Line of Credit (HELOC)?

A HELOC is similar to a home equity loan in that it allows you to borrow money against your home’s equity, while your home serves as collateral. However, instead of receiving a lump sum of money, you would have access to a revolving credit line. You would be given a specific credit limit that you cannot borrow over.

You can borrow as little or as much as you like, as long as it’s not any more than your credit limit. You’ll only be charged interest on the money you actually withdraw rather than the full credit limit. Once you make payments against your HELOC for the funds borrowed, you’re free to borrow again and again, as long as your payments are made on time.

You may have the option to repay interest only, rather than principal and interest. However, this method would take longer to repay whatever you owe and would, therefore, make your mortgage more expensive.

As the principal is paid down, your credit will revolve, which means you’ll be able to use it again and again. After the line of credit expires, the repayment period starts, in which you’ll repay the remaining balance you borrowed, plus interest. You might be able to renew the credit line if your lender approves it.

How Do You Know How Much Equity is in Your Home?

Before you apply for any one of these two unique loan types, you’ll need to figure out exactly how much equity you’ve got in your home. Usually, a professional appraisal will need to be conducted in order to get an accurate and precise number to work with. An appraiser or even a real estate agent will be able to assess your home’s value based on current market conditions.

Once you’ve established your home’s value, you would then subtract the amount that you still owe on your mortgage. Whatever the answer is would be the equity you have to tap into.

Different lenders may have their own eligibility requirements when it comes to how much you can borrow. Your financial history will also play a key role in how much your lender will allow you to borrow against your equity. Generally speaking, lenders allow homeowners to borrow up to 85% of the equity in a home. The more money you borrow, the higher your loan-to-value ratio would be, which can put both you and your lender at greater risk.

To illustrate, let’s say your home has been appraised at a value of $500,000, and you currently still owe $250,000. As it stands right now, your loan-to-value ratio (LTV) would be 50%. If your lender allows you to max out at an LTV of 80%, that means you may be able to borrow no more than 30% of your home equity, or $150,000.

The Bottom Line

To borrow against the equity in your home, you can opt for either a home equity loan or a HELOC. Either one will allow you to gain access to funds needed to cover expensive costs, but they have certain differences. Be sure to speak with your mortgage broker to determine which program is best suited for you.