A home equity loan (HEL) utilizes the equity in a home to provide the borrower with a loan. Borrowers are granted a lump sum of money equal to or less than the equity in their homes. In this case, equity refers to the difference between the fair market value of a home and the amount outstanding on the homeowner's mortgage. For example, if a person's home is appraised at $350,000, but he or she has $220,000 of outstanding mortgage debt, there would be $130,000 in equity.
A home equity line of credit (HELOC) also utilizes the homeowner's equity. Instead of receiving the entire value of the equity in one lump sum, however, a HELOC works more like a credit card with total equity as the credit limit. If you do not have a specific need for the entire equity of your home, a HELOC is your better option. You will be charged interest only on the amount that you borrow, as opposed to interest on the entire sum of your equity as would be the case with an HEL.
A HELOC poses less risk to the lender than an HEL because the total value of the equity is not cashed out all at once. Consequently, the borrower pays a lower interest rate with a HELOC than with an HEL.
Interest rates for both HELs and HELOCs are lower than unsecured loans or credit cards because they are secured by your property. This means that if you decide to move, the entire amount of the loan becomes due. If you are unable to pay, the lender can foreclose on the property, so carefully think through your options before deciding on either an HEL or a HELOC.
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