If you already knew the difference before reading the post, you're more savvy than I, who thought they were different names for the same thing. Not so, Sommers explains:
Home Equity Line of Credit, or HELOC, also allows a homeowner to borrow against the value of their home. The loan is essentially a form of revolving credit in which your home serves as collateral. There are two major differences between this type of loan and a standard HEL. First, a HELOC typically has a variable interest rate rather than a fixed one, meaning that the amount of your monthly interest changes just as it would for an adjustable rate mortgage. The second difference is that rather than receiving the entire amount as a lump sum at the start of the loan, the borrower is given a predetermined line of revolving credit that has a draw period of 5-25 years during which funds can be drawn whenever needed.
There is a maximum limit that can be taken out and a minimum payment that is due each month, with the borrower given the option to pay off as much of the line as he and/or she wants- much in the same way as you would with a credit card or other revolving line of credit. A big advantage that comes with a HELOC is that the borrower pays interest only on the money that they draw, rather than the entire sum as they would with a Home Equity Loan.
Sommers says HELs are better if you're using the money for set expenses, while HELOCs make more sense if the amount of extra money you'll be needing varies.
It's definitely best to avoid either unless absolutely necessary, because both can be gateway drugs to bankruptcy.
Home Equity Loan vs. Home Equity Line of Credit [Budgets Are Sexy]
(Photo: mortgagepaymentplan)
I would find it hard to believe that there are HELOCs structured as you've described. It would be absurd for a bank to allow a homeowner to run up a huge balance on a HELOC and then demand that the entire balance be paid off in one fell swoop. However, if there are indeed HELOCs structured that way, then of course you're right that the homeowner had better make damned sure he/she/they are in a position to pay off the loan when it comes due.
]]>With a second mortgage (Home Equity Loan) you borrow a fixed amount and are paying both interest and principal so at the end of the loan period you are paid off in full.
Another difference is if you make extra principal payments to the HELOC (adjustable rate) it reduces your monthly interest payment due but the end date does not change (unless you pay off in full).
If you make extra principal payments to a Home Equity Loan (fixed rate), the monthly amount due remains the same but the length of the loan shortens.
]]>@plamoni:
He said prime minus 1, so right now he's basically just paying interest (1200/year in payments, 1080/year in interest). Frankly, given that you can get about 2% risk-free, that's about as cheap as capital can possibly get.
]]>Agreed. "Gateway drugs to bankruptcy" is a ridiculous thing to say. I owe my college education to money my parents took out of the equity in their house. Sure, they still owe a lot of money on a house they bought 24 years ago, but they have 3 college educated children (2 with post-graduate degrees with the third in graduate school).
All 3 of us are making quite a bit more money than most people our age. So you could easily argue that my parents' choice to cash in on their home equity was the complete opposite of a "gateway drug to bankruptcy." Because their decision to invest some of their home equity in our educations will probably mean far greater financial security in their old age because they won't have to worry about taking care of us.
Home equity instruments are no more a gateway drug to bankruptcy than marijuana is a gateway drug to, well, drugs.
]]>So let me get this straight... You're borrowing money at a variable rate to invest elsewhere in the middle of an economic crisis? That sounds like a pretty risky thing to do.
Plus, it's a good thing you're not in a rush to pay it off. With an interest rate of prime + 1% and a $48,000 balance, if you make payments of $100 a month, even at a prime rate of 0%, it will take over 50 years to pay off your debt. With the current prime rate of 3.25%, you'll never pay off you debt. Ever.
I hope you have a lot of life insurance.
]]>If you are financially secure, a HELOC is *significantly* better than most anything else on the market.
My Visa is at 13%. My HELOC is at 9%.
BUT. . . my HELOC interest is tax deductible.
My Visa gives me enough points to buy a blender a year, maybe.
Lastly, the HELOC by design is equal to or less than the equity in your house. Thus, if I had to sell my house, as long as I can make back the purchase price for it, the HELOC isn't a problem.
Again, that's an issue for the folks underwater, but I'm not in that boat, because I didn't buy more house than I could afford with a loan that would go insane in a few years.
HELOC, like all financial tools, is a great deal for those able to manage their use.
]]>Hogwash!
What leads to bankruptcy is running up the balance on your HELOC to more than you can afford. Used responsibly, a HELOC is no more dangerous than any other type of loan (mortgage, HEL) whose collateral is your house.
We refinanced our mortgage years ago into a HEL and HELOC from the same bank. The bank subsequently refinanced the HEL for free at a lower rate, and doubled the size of the HELOC. When the prime rate plummeted in the downturn, we paid off the remaining balance on the HEL using the HELOC, since the interest rate on the HELOC was more than 3% lower than the rate on the HEL.
The fact that we have a HELOC allows us, for example, to:
* Use the HELOC as our emergency fund so that we don't have to keep lots of cash on hand making lousy interest.
* Participate in my employer's ESPP, making at least a 15% return on my money every six months, at which point I sell enough of the stock to get back the initial stake and put it back into the HELOC to pay down the balance.
* Put as much money into my 401k as my employer matches, even though that means going cash-flow negative and increasing the HELOC balance, because even at the higher balance; we are essentially transferring equity from our house into our 401k, and making a substantial return on it because of the employer matching which we'd be fools to pass on.
* Get a tax deduction for the interest we pay on the HELOC.
The maximum balance on our HELOC is well below the value of our house and well below what we can afford to pay off, so even if we max it out and have to stop doing the ESPP / 401k contributions temporarily, we'll still be able to pay it off without worrying about bankruptcy.
]]>@Gannoc: Indeed. Significant enough, in fact, that it was the first of the two differences mentioned.
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