Homeownership provides a potential source of borrowing power: Once you build up home equity, you can tap it as a great source of funds when you need money.
The equity — the difference between your house’s fair market value and the balance on your mortgage — can offer some of the lowest-cost lending available, through a home equity loan or what’s called a HELOC.
They’re similar, but here’s a look at the key differences, to help you decide which option is better for your situation.
Home equity loans: Access equity now
A home equity loan is a second mortgage that allows you to access real estate equity in big one chunk.
After the loan closing, the lender either cuts a check for a lump sum or wires funds to the borrower.
If you own a home worth $300,000, with a $200,000 balance on your first mortgage, you would potentially be able to tap $100,000 in equity.
Some home equity loans allow you to borrow up to the full 100% of your available equity, while others may cap the loan at 85%, 90% or 95%.
HELOC: Credit available now and later
A home equity line of credit, or HELOC, is different from a home equity loan in that you can borrow only what you need now but potentially take more later.
The credit line is similar to the available credit on a credit card. You pay interest only on the money you’re using.
In the example home with $100,000 in equity, a borrower could obtain the credit line in any amount up to $100,000.
Your loan payments would be based on the outstanding balances from all of your draws from the line.
Paying off a home equity loan or HELOC
With either a home equity loan or a HELOC, your repayment can be amortized, meaning scheduled out over a period of time and including interest and principal in your installments.
Under a 10-year amortized home equity loan for $100,000, your payments would gradually take your balance down to zero.
Be aware that home equity loans and HELOCs can come with balloon payments, where one large payoff amount may be due at the end.
In those situations, a home equity product with low monthly payments can suddenly turn into a very bad deal. Be sure to ask upfront if your loan or HELOC has a balloon payment — and avoid major regrets later on.