When you want to cash in on your home's value without selling it, you may consider getting either a home equity loan or a home equity line of credit (HELOC).
But how do you know which option is right for you? And what are the differences between these similar-sounding mortgage products?
Here's a primer on the differences between home equity loans and home equity lines of credit — along with the pitfalls of each, and when it's typically best to use one over the other.
In a nutshell, a home equity loan or a HELOC is based on the the current value of your home minus any outstanding loans plus the new one you're getting.
When you add them both together — the first mortgage + the second mortgage — that creates the loan-to-value (LTV) ratio. A lender typically won't exceed 80 percent of the home's appraised value, based on most bank guidelines for a home equity loan or a HELOC. But some banks may go as high as 85 or 90 percent LTV on either a HELOC or a home equity loan.
The basics of home equity loans
A home equity loan is often called a second mortgage because, like your primary mortgage, it's secured by your property — but it's second in line for payoff in case of default. The loan itself is a lump sum, and once you get the funds, you can't borrow any more from that home equity loan.
Since you receive money in a lump sum, these loans are most suitable when you need cash all at once, or for a specific one-time event, such as paying for a wedding, financing major home renovations or getting rid of other obligations such as high interest rate credit-card debt.
One benefit of a home equity loan is that it usually carries a fixed interest rate, making your monthly payments highly predictable. That's important if you're living on a fixed income or want to know precisely what your mortgage repayment will be for the life of the loan.
Home equity loans are also fully amortized loans, so you'll always be repaying both principal and interest, unlike home equity lines of credit that let you make interest-only payments. With interest-only loans, you will face higher payments when you must pay down the principal as well.
Home equity lines of credit, or HELOCs
HELOCs typically have fewer up-front costs than home equity loans. But there are fees. For example, Chase charges a loan origination fee, as well as an annual fee of $50 for these loans. Most banks also charge appraisal fees to verify the market value of a home. A home equity line of credit also differs in the way that funds are disbursed to you. Instead of providing you with a lump sum as with a home equity loan, a HELOC lets you access the equity in your home on an as-needed basis, up to the full amount of your credit line.