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Home Equity Line of Credit (HELOC) and Home Equity Loans

There is some confusion regaring the difference between a Home Equtiy Line and a Home Equity Loan. Understanding them is a basic fundamental of personal finance.

A home equity line of credit or HELOC is a "line of credit." It seems obvious, but if you stop and think it through it can really help. Your credit card is also a credit line. Just like your credit card, your HELOC has a credit limit. That credit limit is the maximum amount of credit that you can get under your HELOC. So, if you apply for a $25,000 Home Equity Line of Credit you are applying for what is essentially a credit card with a $25,000 limit except in if you don't pay this one back, they'll take your house. (These days some HELOCs actually come with a Credit Card!)

This means that you do not have to take the full $25,000 right away. In fact, you never have to take the whole $25,000. If you get a $25,000 HELOC to remodel your kitchen and it only costs $18,000 you can take just $18,000. You only pay interest on the money that you have actually taken, so in this case you would be paying interest on $18,000 only.

A Home Equity Loan on the other hand is much more like your mortgage. A home equity loan is full amortized. That means that when you get a $25,000 Home Equity Loan, they give you a check for $25,000 and you start paying interest on the whole $25,000 right away. Also, unlike a home equity line of credit this is a one time funding. You can't go back and take money out again once you've paid it off. So, if you get your $25,000 and you make $10,000 worth of payments, you can't go get $10,000 under the same loan. (You would have to re-apply for something else.)

Why would anyone ever do a home equity loan? The main reason is that home equity loans usually have a fixed interest rate whereas a HELOC usually has an adjustable rate. This makes a very big difference when interest rates are rising. With a home equity loan you know what your payment will be until the loan is paid off. With a HELOC, you are taking a chance on interest rates.

So which is best for you? It depends on what you are going to do with the money. If you need a one time lump sum of cash and then just want to pay it off, then the home equity loan is the way to go. If you might need some money now, and might need some moeny later, then the HELOC is the way to go. Just keep in mind with an adjustable rate to not get in over your head. Make sure you can comfortably make the payments now because they might be higher in the near future. If you can barely make the payments now, then your HELOC amount is too high and you can get into big trouble if rates rise.