A home equity line of credit, or HELOC, is an alternative to an equity loan. While there are a few core distinctions in these financing options, the primary one is that a HELOC is the right to borrow funds, whereas an equity loan is a lump sum distribution.
Home equity loans and HELOC are similar in that they both involve financing based on the equity in your own. With a loan, the bank pays you a lump sum amount that you then repay with regular monthly installments over the loan term. While the term is typically shorter, the repayment structure is much the same as that of your primary mortgage. Equity loans normally have higher closing costs than credit lines because HELOCs don't require a formal closing.
With a HELOC, the bank gives you access to a limit of credit based on your home's equity. A $40,000 line, for instance, means you have approval to borrow up to $40,000. You don't get a lump sum up front; instead, you borrow funds using a debit card, convenience checks or transfers from the account. Your loan balance is whatever you have borrowed up to that point. Loan payments are based on the principal balance, though some HELOCs only require interest payments during the upfront draw period. The draw period is the time during which you can access the funds, often 10 years. After that, the loan is set up on an amortized repayment schedule like the equity loan.
Though people sometimes use these loans interchangeably, each has benefits that apply best in certain situations. Someone who knows the the exact amount needed for a project or expenditure and prefers a predictable payment structure is a good candidate for an equity loan.
In contrast, a HELOC is designed more for someone who can't predict total costs or needs to utilize the funds over an extended period. Home renovation projects that take several months may require intermittent payments rather than one upfront payment. Thus, the borrower needs continued access. In these scenarios, MyFICO points out that it is better to hold off on paying interest until you actually have to make use of the funds. When you get an equity loan, you begin paying interest at the time of distribution.