Types of Home Equity Loans

Home equity loans allow you to borrow against the money you've invested in your mortgage. Essentially, a home equity loan is a 'second mortgage' secured by your property. If you fail to make 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 (HELOCs). Most lenders offer both kinds, but they have different features.

Home Equity Loan

If you are granted a home equity loan for $10,000 at 7% APR for 15 years, you will receive a check or a deposit of $10,000. This is the full amount of the loan you can draw on that application. Depending on the terms, you may have a few months before you must start repaying the loan. You will pay a fixed amount every month until the loan and interest are paid off. From the start, you'll know the total repayment amount.

Home Equity Line of Credit (HELOC)

A HELOC is more like a credit card. When granted a HELOC, the bank establishes a line of credit, functioning like a credit limit on your card. You may receive special checks or a plastic card to access your credit line, but you don't get the full amount at once.

You can draw on the line of credit at any time, up to the full amount, during the loan's agreed-upon life. For example, you can use your HELOC to pay for $2,000 worth of roofing tiles, leaving you with $8,000 in your line of credit. Later, you can use it to pay for $4,500 worth of windows, leaving $3,500. As you pay back the borrowed amount, that money becomes available again. If you repay $1,000, you now have $4,500 on your line of credit.

A HELOC has two phases: the draw period and the repayment period. During the draw period, you can draw against the credit limit and can choose to pay only the interest or make principal payments to free up credit. Once the draw period ends, the repayment period begins. During the repayment period, you can't draw against the line of credit any longer and must make full repayment.