Home equity loans and Home equity line of credit are two terms, which are sometimes used interchangeably, but refer to different financial products. It is important to clearly understand the difference between these two terms.
Understanding the concept of a home equity line of credit
A home equity line of credit is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer's largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills and not for day-to-day expenses.
With a home equity line of credit, you will be approved for a specific credit limit, which is the maximum amount you may borrow at any one time under the plan. Many lenders set the credit limit on a home equity line by taking a percentage (say, 75 percent) of the home's appraised value and subtracting from that the balance owed on the existing mortgage.
In determining your actual credit limit, the lender will also consider your ability to repay, by looking at your income, debts, and other financial obligations as well as your credit history. Many home equity line of credit plans set a fixed period during which you can borrow money, such as 10 years. At the end of this "draw period," you may be allowed to renew the credit line. If your plan does not allow renewals, you will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period (the "repayment period"), for example, 10 years.
Once approved for a home equity line of credit, you will most likely be able to borrow up to your credit limit whenever you want. Typically, you will use special checks to draw on your line. Under some plans, borrowers can use a credit card or other means to draw on the line.
There may be limitations on how you use the line. Some plans may require you to borrow a minimum amount each time you draw on the line (for example, $300) and to keep a minimum amount outstanding. Some plans may also require that you take an initial advance when the line is set up.
Understanding the concept of a home equity loan
A home equity loan is like a line of credit that allows you to borrow money, using your home's equity as collateral. The collateral is property that you pledge as a guarantee that you will repay a debt. If you don't repay the debt, the lender can take your collateral and sell it to get its money back. With a home equity loan, you pledge the equity of your home as collateral. Equity implies the difference between the worth of your home and the debt you owe in mortgage (or mortgages in case there are many of them).
Difference between home equity loan and a home equity line of credit
| No. | Home equity loan | Home equity line of credit |
| 1 | Better used for fixed expenses.
E.g. Painting a room | Better used for variable or ongoing expenses.
E.g. Remodeling a house |
| 2 | May have to endure the application process repeatedly | Endure the application process once |
| 3 | No annual fees involved | Annual fees maybe involved |
