February 2018
In simple terms, a home equity line of credit works a little like a credit card - a credit card secured by your home. Lenders approve you for a specific amount of credit, but you are not required to borrow up to the limit of your credit line.
How a Line of Credit Works
Here's an example. Say you are approved for a home equity line secured by the equity in your home. Most lenders will limit how much you can borrow, using a percentage of your home's value as a guideline.
In this example, we will assume you have been approved for a $30,000 credit line.
You can draw funds at your discretion in any frequency or amount during the term of your loan up to the $30,000 limit. In addition, your account may automatically renew from year to year after the initial term. You are charged interest only on the amount you have drawn and payments may be calculated using an “interest only” method or figured using a percentage of your outstanding balance. As you pay down your balance, those funds become available to borrow again and again.
With a home equity loan you receive the entire loan amount up front. If you borrow $30,000, you receive a check for $30,000, and you start making payments on that $30,000 loan immediately based on a predetermined repayment period.
Here is a quick breakdown of the differences between home equity loans and home equity lines of credit:
| Item | Home Equity Loan | Home Equity Line of Credit |
|---|---|---|
| Receipt of Funds | Received up front in one lump sum, typically by check or direct deposit to an account. |
Funds can be accessed at any time by check, in-person withdrawal or online transfer. |
| Interest Rate | Typically fixed and applied to entire loan amount. |
Usually variable; applied only to the outstanding principal balance |
| Repayment | Usually installments over a defined repayment term. |
Can vary depending on repayment method and interest rates. |
Interest Rates
Home equity lines of credit generally use variable interest rates instead of fixed interest rates. The rate will vary based on a common index like the prime rate. Typically the interest rate is calculated by adding a percentage, called the margin, to the index; for example, your interest may be calculated using "prime rate plus 1%." In that example, if the prime rate is 5%, your interest rate will be 6%. The rate will change based on changes in the index and will impact your payment amount and/or repayment period.
A home equity loan usually has an interest rate that is fixed for a defined term which may be all or part of the repayment period. You have confidence in knowing your interest rate and payment amount will not change for a predetermined period of time.
Which is Right for You: Loan or Line?
Home Equity Loan
- Home equity loans are often used for one-time expenses (home improvements, major purchases, etc).
- Home equity loans often come with fixed interest rates and fixed monthly payments, making budgeting simple.
- Home equity loans will generally require higher monthly payments.
- Payments include interest and principal (using a standard amortization schedule).
- No additional funds are available; to access more cash, you will need to refinance or take out another loan.
Home Equity Line of Credit
- Home equity lines are often used for recurring and unexpected cash needs.
- Home equity lines often come with variable interest rates; your rate can rise or fall based on changes to the prime rate.
- Payment amounts will also vary based on how much money has been borrowed at any given time.
- Payments are often interest-only, but can include principal. During the term of the loan, you will make lower monthly payments but will owe the entire principal balance when the loan term ends.
- Funds can be accessed at any time, and if you pay down the balance, you can draw against that money again and again during the term of the loan.
Need a simple way to decide between a home equity loan and a home equity line of credit?
If you need a lump sum at one time, and want the stability of a fixed interest rate and fixed monthly payments, choose a home equity loan.
If you want greater flexibility and the ability to choose when and how much you will borrow, and are willing to accept the potential for changing interest rates and payment amounts, choose a home equity line of credit.
To speak to a lender about whether a home equity loan or a home equity line of credit is the best choice for your individual needs and goals, simply call our Customer Service Center at (262) 549-8500, click here to schedule an appointment or stop into any of our convenient locations.