Home Equity Loans vs Home Equity Lines of Credit

Your home equity is the market value of your property minus the amount you own on your home loan. Home equity is typically built up over time through your principal payments and real estate appreciation. During periods when home prices are appreciating quickly your home equity will likely increase but in years when the market is down you will probably lose home equity.

Some banks will let you borrow against the accumulated value of your home if you have enough equity built up. These types of loans are known as second mortgages and there are two main types: a home equity loan and a home equity line of credit.

Home Equity Loan

In general, a second mortgage of this type is a loan that comes in a single lump sum. You have to remember that it is an entirely different loan from your original mortgage. You will need to have a credit check and fill out a mortgage application. You’ll also need to keep your eye on interest rates and lock in at the best mortgage rate you can find.

A second mortgage in this form is sometimes used for debt consolidation. People who have high interest debt may borrow at the lower rates available via home equity loans and use the money to consolidate all their debts at a lower interest rate. One of the financial benefits of this approach is that the interest you pay on a home equity loan is tax deductible, unlike interest you might pay on a credit card.

Another popular use for home equity loans used to be borrowing money for big home improvement projects. Of course the problem people ran into was that when the value of their home decreased, they still had to pay back the loan even though their house was no longer worth the amount they had borrowed against. Now days credit in general is harder to come by and banks are less likely approve loans of this type.

You do have to be careful when taking out a home equity loan since you are adding to your debt levels. If you default on a home equity loan your home can be foreclosed on so it is important to carefully think about whether you want to take that risk with your home.

Home Equity Line of Credit

Unlike the home equity loan, which is usually paid in one lump sum, a home equity line of credit is a type of revolving credit that allows you access to an approved amount of the equity in your home for a fixed period of time.  Typically you’re given special checks or a credit card that you can use to tap into your equity as needed.

This is still another loan, so you will have to go through the credit and application process and the bank will determine how much equity they’ll let you borrow against. Once you are approved for a line of credit, you can get money as you need it for the life of the loan, known as the “draw period.”

Most home equity lines of credit come with variable rates, rather than fixed rates, so your payment can change as you pay off the loan. Like a home equity loan, the interest you pay on a line of credit may provide you with a tax deduction.

It is important to be careful with home equity lines of credit, since you have access to the cash it can be tempting to take more money than you need.

Bottom Line

If you’ve built up equity in your home the home equity loan and line of credit make it possible for you to access that money without selling your house. While the interest you pay is tax deductible you are putting your home at risk by taking out a second mortgage so be sure you have a plan to pay it back before taking out the loan.

Miranda writes about personal finance almost every day. An experienced freelance writer, she's covered your money online and in print from every angle and is always looking for new ones.

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