Home equity loan or line of credit: 5 questions

Some people use the terms "home equity loan" and "home equity line of credit" interchangeably. They mean very different things, however, and if you're considering borrowing against the equity in your castle, you should have a clear understanding of the differences and what they may mean to you.

For starters, a home equity loan might be the best fit if you plan to use the money in a lump sum for a one-time occasion such as consolidating your credit card debt, replacing the roof or paying for your daughter's wedding. The interest rate is fixed, and so are the monthly payments so you can budget accordingly.

A HELOC -- home equity line of credit -- might be a better fit if you will need money periodically and not all at once. This is the case in lengthy home remodeling projects when you pay the contractor in two or more draws. Or perhaps you will need to shed an arm and a leg at the beginning of each semester over the next four years when the kids head off to college. A HELOC gives you the flexibility to borrow what you need, when you need it.

Research before you leap. You can start by asking yourself these five questions to help you choose which is best for you:

Do I need the money in a lump sum or in several installments?

If you need it in a lump sum, lean toward getting a home equity loan. If you need the money in installments, lean toward getting an equity line of credit.

Is it for a long-term purpose or a short-term purpose?

If the money is to be spent on something that will last a long time, such as a roof or a car, an equity loan might be better. If the money is to be spent on something that won't last long, such as a semester in college or a wedding and reception, think about getting an equity line of credit.

How big a monthly payment can I handle?

A home equity loan requires you to pay principal and interest every month for the life of the loan. A home equity line of credit allows you to pay just the interest for several years, if that's what you want to do. It's a whole other question whether it's a good idea to pay only the interest, and not the principal, for a long time.

Would a line of credit tempt me to use the money carelessly?

Naturally, if you answer this in the affirmative, you should consider getting a home equity loan because you pay off the principal and interest over time, and it's not a revolving credit account.

Does a variable rate bother me?

A home equity line of credit has an adjustable rate that most likely changes every time the Federal Reserve raises or lowers the federal funds rate. If you don't like the idea of having a rate that could rise every time the Fed meets, consider getting a home equity loan, which has a fixed rate.

By Bankrate.com