 Comparing
HELOCs and home equity loans
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 Dear
Dr. Don,
What is the difference between a home equity loan and a home equity
line of credit?
-- Willie Wonders
 Dear
Willie,
A home equity loan has a fixed interest rate, monthly loan payments sized to pay off the loan over its term, also known as a self-amortized loan, and you receive the entire loan amount as a lump sum when you close on the loan.
In contrast, a home equity line of credit, or HELOC,
is a variable-rate loan, with changes in the interest rate typically
tied to changes in the prime rate, which is itself tied to changes
in the targeted federal funds rate. The Federal Reserve Board's
Open Market Committee meets eight times per year to discuss the
economy and decide whether to change the targeted federal funds
rate. The committee raised the fed funds rate by one-quarter percent
each time at six of the past eight meetings, but has kept the rate
constant at the last two meetings.
Besides having a variable interest rate, a HELOC has interest-only payments, at least in the early years of the loan. Some HELOCs are structured to have interest-only payments over the entire loan term with a balloon payment at the end of the loan. Other HELOCs become self-amortizing loans after an initial period of interest-only payments.
Because it's a line of credit, you only borrow what
you need, although there might be a minimum draw against the line
when you close on the loan. At least for part of the loan term,
the credit line is a revolving credit. Paying down the loan balance
frees up credit capacity.
The changes in the federal funds rate over the past
2½ years have caused the interest rates on HELOCs to rise above
the fixed rate of a home equity loan. Bankrate's national average
for a HELOC is 8.21 percent and for a home equity loan it is 7.91
percent as I write this. That doesn't mean that the loan is necessarily
the better choice. What you plan to do with the money and managing
the monthly payments are important considerations, as well as what
you think will happen with interest rates over the life of the loan.
It's important to know how the interest rate is set with the HELOC.
These loans can have rate ceilings and floors that limit how the
rate adjusts.
Those are the basics on HELOCs and home equity loans.
Bankrate has a whole channel on its site devoted to home
equity lending, including a section that can help you decide
which
loan is right for you.
To ask a question of Dr. Don, go to the "Ask
the Experts" page and select one of these topics: "financing
a home," "saving & investing" or "money."
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