Home equity loans are a way of using the money that you've invested in
your mortgage by borrowing against it. Essentially, a home equity loan
is a 'second mortgage' - a loan secured by your property. If you don't
make good on your payments, the lending company or bank can force the
sale of your house to recover their money.
There are two major types of home equity loans - home equity loans and
home equity lines of credit, also called HELOCs. Most lenders that
offer home equity loans offer both kinds. A home equity loan for
$10,000 and a home equity line of credit for $10,000 are two completely
different animals though they have a lot of similar features.
Home Equity Loan
If you apply for and are granted a home equity loan for $10,000 at 7%
APR for 15 years, you will receive a check or a deposit to your bank
account of $10,000. That is the full amount of the loan that you can
ever draw on that particular application. Depending on the terms agreed
upon, you may have one to several months before you have to begin
repaying the loan. You'll pay a fixed amount every month until the full
amount of the loan and the interest charge is paid off. You'll know
from the very start how much you'll be repaying.
Home Equity Line of Credit
A home equity line of credit - a HELOC - is much more like a credit
card. When you apply for and are granted a home equity line of credit,
the bank establishes a 'line of credit' - which functions just the way
that a 'credit limit' does on your credit card. You may receive special
checks or a plastic card with which to access your line of credit - but
you don't receive the full amount at one time.
In fact, you don't have to take any of it immediately. You can draw on
the line of credit at any time, up to the full amount of the line of
credit throughout the agreed-upon life of the loan. Suppose that you're
doing some home repairs. You can use your home equity line of credit to
pay for $2,000 worth of roofing tiles. That leaves you $8,000 in your
line of credit. Three weeks later, you can use your line of credit to
pay for $4,500 worth of windows - and still have $3,500 left that you
can borrow against.
If you then start paying back on your home equity line of credit, that
money becomes available to you again. If you pay back $1,000 of what
you've borrowed, you now have $4,500 on your line of credit.
A home equity line of credit has two 'phases' - there is the draw
period, during which time you can draw against the credit limit as long
as you stay below the limit. During that time, you can elect to only
pay the interest that accrues - or you can make payments on the
principal to free it up. Once the draw period is over, you go into the
repayment period. During the repayment period, you can't draw against
the line of credit any longer, and must make full repayment.
