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Understand the difference between home equity loans and a home equity line of credit

Homeowners often wonder how they can use the equity in their home to access low-interest financing. A home equity loan or line of credit are two options available to you. To find out which one will best suit your needs, check out some of the differences below.

Home Equity Loan (HEL)

A home equity loan is a good way to borrow money. This option allows you to get a fixed amount and receive it in a lump sum. The amount you receive is based on your home’s value, payment terms, verifiable income and credit history. You can get it with a fixed rate, fixed term, and even a fixed monthly fee. Additionally, interest payments are 100 percent tax deductible.

Home Equity Line of Credit (HELOC)

With a home equity line of credit, you don’t get all your money at once. Instead, you open a revolving credit, which allows you to receive money as you need it. Your house is used as collateral to open the credit account. Companies approve this type of account based on the appraised value of the property and subtracting the current balance of the existing mortgage. Some consider income, debt ratio and credit history.

Unlike a HEL, in a HELOC you withdraw funds as needed over a period of time, typically five to ten years. Plans vary and you may have special checks or a card to use to access your funds. Depending on your account, you may need to borrow no less than a fixed amount each time you access your account. You may also be required to maintain a minimum outstanding balance. Some plans also require a specific initial withdrawal.

After the “draw period” ends, some HELOC providers will allow you to renew the terms of the account. Not all lenders allow you to renew the plan. In addition, once the “disposal period” has ended, the “return period” is entered. Your lender may require you to pay the full amount at this time. Others allow you to install.

How do they differ?

While both a HEL and a HELOC allow you to tap into the value of your property to gain access to financing, there are two main differences. Those are the interest rates and payment terms.

With a HEL, you get a fixed interest rate. This means that you know what your interest rate is from month to month. This also makes your payments fixed, making it easier to budget each month.

However, a home equity line of credit usually has an adjustable rate. This means that the monthly interest payment may change depending on the index. Lenders traditionally add a margin of a few percentage points to the prime rate. You should ask the lender what rate is used, what is the margin charged, how often is the rate adjusted, and what is the maximum and minimum rate limit.

Since the interest is adjustable, the monthly installments fluctuate. Also, during the withdrawal period you may be responsible for paying only the monthly interest, without paying the principal until after the payment period begins.

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