There are basically two types of home equity loans: a home equity loan (HEL) or a home equity line of credit (HELOC). Since the debt is secured by your home, the interest rate is typically less than that of a credit card or personal loan. Also, the interest paid on the loan may be tax deductible (always check with your tax or financial advisor before making any tax-related decisions).

Home Equity Loan (HEL)

A home equity loan, also referred to as a second mortgage, is best used in situations where you intend to use the funds for a specific purpose, like home improvements or a car purchase. The interest rate and the monthly payments are fixed. These get paid back in installments over a fixed period of time, typically 10-15 years. While the time to repay a loan is shorter than that of a traditional mortgage, borrowers like the certainty of having a fixed rate and fixed monthly payments.

Home Equity Line of Credit (HELOC)

A home equity line of credit is a revolving line of credit for which you make monthly payments on the borrowed amount. It works like a credit card and is best used when you do not need all the money upfront. The interest rate is variable and in most cases tied to prime. The rate for which you qualify is usually based on your creditworthiness and your ability to repay the loan.

Advantages and disadvantages of using each type of loan Knowing when to use which type of loan depends on your specific circumstances. If you have a long term remodeling project which requires cash installments over time, then a line of credit makes sense. If your home needs a major upgrade and if you are making one large payment, then the stability of a home equity loan may be a better choice.

Advantages of HELs and HELOCs

HEL (Home Equity Loan)

• Fixed interest rate – Although you pay interest on the entire borrowed amount, your rate is locked in if rates swing upward. - Attractive mortgage rates (lower than credit cards or personal loans).
• Loan interest may be tax-deductible.
• There is one lump sum of money borrowed.
• Set monthly payments make it easier to estimate your expenses.

HELOC (Home Equity Line of Credit)

• Variable interest rate – Pay interest only on the amount you access from your line of credit, rather than the entire loan amount.
• Attractive interest rates (lower than credit cards or personal loans).
• Loan interest may be tax-deductible.
• Access to money as you need it.
• Interest-only [link to glossary] repayment options are available.

Disadvantages of HELs and HELOCs

HEL (Home Equity Loan)

• Required to borrow the entire amount upfront whether used or not.
• Fixed payments can take up to 15 years to repay
• There are usually numerous fees that add costs to the loan amount.
• Repayment of interest and principal begins as soon as you receive the money.
• If you can’t repay or refinance the
  loan, then you may be forced to sell or lose your home.

HELOC (Home Equity Line of Credit)

• Knowing money is available at any time can be tempting.
• Variable interest rate could adjust upward.
• There are usually numerous fees that add costs to the loan amount.
• Interest-only repayment options are available from most lenders.
• If you can’t repay or refinance the loan, then you may be forced to sell or lose your home.

While the advantages for both types of loans may sound appealing, carefully evaluate whether the benefits each has to offer is worth incurring the additional debt.