HELOC vs. Home Equity Loan: What’s the Difference?
A HELOC is a line-of-credit, as its name (Home Equity Line Of Credit) implies. It works like a credit card, allowing people to borrow and pay back the equity in their home at some interest rate. The interest rate can be variable or fixed, and the interest is simple interest, not compound interest. People can typically access their HELOC much like a checking account, writing checks against the equity in their home. The home is used as collateral, so essentially a HELOC is a simple interest, secured credit resource hybrid of a credit card and checking account. Since you can draw from the available credit, you only pay interest on the money you’ve borrowed, not the entire credit line. Interest rates on a HELOC tend to be higher than on an equity loan, but lower than on credit cards since it’s a secured debt.
A Home Equity Loan, in comparison, is a second mortgage on your home. It’s compound interest and functions exactly like a mortgage loan, because that’s what it is. It’s a lump sum principal balance paid back to the lender on an amortization schedule, using the equity of the home as “cash out” and securing the debt with the home asset. Monthly payments are consistent until the loan is paid off or recast with a change in terms. Whether you use all the money from the loans funds or not, you’ll be paying interest on the entire loan balance.
So the two have the similarity of using the home as collateral, but one is simple interest with “in and out” money, and the other is compound interest with a lump sum balance.