Home equity loans are a way of using the money that you’ve
invested in your mortgage by borrowing against it. Essentially,
a home equity loan is a ‘second mortgage’ – a loan secured by
your property. If you don’t make good on your payments, the
lending company or bank can force the sale of your house to
recover their money.
There are two major types of home equity loans – home equity
loans and home equity lines of credit, also called HELOCs. Most
lenders that offer home equity loans offer both kinds. A home
equity loan for $10,000 and a home equity line of credit for
$10,000 are two completely different animals though they have a
lot of similar features.
Home Equity Loan
If you apply for and are granted a home equity loan for $10,000
at 7% APR for 15 years, you will receive a check or a deposit to
your bank account of $10,000. That is the full amount of the
loan that you can ever draw on that particular application.
Depending on the terms agreed upon, you may have one to several
months before you have to begin repaying the loan. You’ll pay a
fixed amount every month until the full amount of the loan and
the interest charge is paid off. You’ll know from the very start
how much you’ll be repaying.
Home Equity Line of Credit
A home equity line of credit – a HELOC – is much more like a
credit card. When you apply for and are granted a home equity
line of credit, the bank establishes a ‘line of credit’ – which
functions just the way that a ‘credit limit’ does on your credit
card. You may receive special checks or a plastic card with
which to access your line of credit – but you don’t receive the
full amount at one time.
In fact, you don’t have to take any of it immediately. You can
draw on the line of credit at any time, up to the full amount of
the line of credit throughout the agreed-upon life of the loan.
Suppose that you’re doing some home repairs. You can use your
home equity line of credit to pay for $2,000 worth of roofing
tiles. That leaves you $8,000 in your line of credit. Three
weeks later, you can use your line of credit to pay for $4,500
worth of windows – and still have $3,500 left that you can
borrow against.
If you then start paying back on your home equity line of
credit, that money becomes available to you again. If you pay
back $1,000 of what you’ve borrowed, you now have $4,500 on your
line of credit.
A home equity line of credit has two ‘phases’ – there is the
draw period, during which time you can draw against the credit
limit as long as you stay below the limit. During that time, you
can elect to only pay the interest that accrues – or you can
make payments on the principal to free it up. Once the draw
period is over, you go into the repayment period. During the
repayment period, you can’t draw against the line of credit any
longer, and must make full repayment.