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The difference between a home equity loan and a line of credit

After being in the gutters for several years, home values are once again beginning to rise in Wisconsin and the rest of the United States. What that means is homeowners are once again able to turn to home equity loans to borrow money.

However, what most people aren't aware of is that there are a couple of options when it comes to home equity loans. The first is a traditional term, or closed-end home equity loan, but there is also an option called a home equity line of credit (HELOC).

Essentially, the term home equity loan is when homeowners take out a one-time lump sum of money that is secured by the mortgage. Known as a second mortgage, the home equity loan is paid off over a set period of time with a fixed interest rate.

Interestingly, HELOC is also called a second mortgage, though it works more like a credit card account than a loan. A HELOC allows homeowners to borrow money as needed (but only up to a certain amount) during the life of the mortgage.

The line of credit tends to give homeowners more flexibility because it allows them to "recycle" credit. For example, if a mortgage has a credit line of $10,000 and the homeowner borrows $8,000 and then pays off $5,000 of that amount the homeowner now has access to $7,000.

Unlike the home equity loan, the interest rate for credit lines fluctuates throughout the life of the loan.

One of the most common reason people take out home equity loans is to pay off credit card debt. A home equity loan allows the homeowner to borrow money to pay off credit card debts at a lower interest rate than the credit card companies were charging.

Check back later this week for more on home equity loans and HELOC, in particular.

Source: Bankrate.com, "Home equity loan vs. line of credit," accessed Nov. 3, 2014 

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