What is the Difference Between a Home Equity Loan and a Home Equity Line of Credit?

Home Equity Loans vs HELOC
As more and more homeowners look to use their home equity as an option for low-interest financing, it can be confusing to know if a Home Equity Loan or a Home Equity Line of Credit (HELOC) is the better option. Both are secured by your home and offer rates that are lower than unsecured loans or credit cards and may offer tax benefits depending on how the loan is used. Both can be good solutions to finance a variety of uses including home improvement, debt consolidation, major expenses (weddings, education, etc.), and refinancing. However, there are differences to understand so you can select the right option for you.

Home equity loans typically carry fixed interest rates. In a changing rate environment, a fixed rate loan can provide a borrower some assurance because the monthly payment amount and interest rate remain the same over the life of the loan. On the other hand, HELOCs typically carry a variable interest rate that will change periodically if the rate index changes. If the index increases or decreases, the interest rate will increase or decrease and your monthly payment will increase or decrease. Some lenders now offer a hybrid or fixed rate option for a HELOC. You can convert all or some of the money from a variable rate into a fixed rate during the draw period, typically for a fee. While this can give you a sense of certainty, the interest rates on fixed-rate HELOCs are often higher than market rates and there may be a fee associated with the rate conversion. Because home equity loans and HELOCs are secured by your home, interest rates are typically lower than unsecured loans like credit cards or personal loans.

Home equity loans are disbursed in one lump sum and the borrower is expected to make regular monthly payments of principal and interest for the agreed-upon repayment term. Some lenders may charge a pre-payment fee if the loan is paid in full before the end of the repayment term. With Discover Home Equity Loans, if the loan balance is paid in full within 36 months after your loan closes, you will be required to reimburse some of the closing costs, not to exceed $500.

HELOCs work like a credit card. The borrower can withdraw money as needed during a period of time set by the lender, known as the draw period. If the borrower withdraws money during the draw period, they may be required to make small, interest payments. Once the draw period ends, the borrower can no longer withdraw any more money and is now expected to make full payments of principal and interest for the agreed-upon repayment term. While there is money available to the borrower with a HELOC, the lender can revoke the amount available if the borrower’s financial situation worsens or if their home value changes.

Closing costs and fees vary by lender. Home equity loans act like a mortgage with various fees and closing costs, but it depends on the lender. A HELOC may have upfront costs including an application fee, title search, and appraisal fees. In addition, a HELOC may include fees throughout the life of the loan, including an annual membership fee or a transaction fee. It’s best to shop around and discuss all fees with lenders. Discover Home Equity Loans charges you no application fees, no origination fees, no appraisal fees, and no cash is required at closing. If you’re interested in applying for a Discover Home Equity Loan, you can apply online now and see if you prequalify in minutes.

When considering your options, make sure you evaluate how you plan to use the money and how does this fit within your long-term financial plans. It’s important to not only compare your options but also compare lenders to determine what loan best works for your unique situation.

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