With home values finally recovering from their steep declines of the last half decade, and interest rates still hovering around their historic lows, homeowners are, once again, looking to their home equity for financing. Among all of the factors that go into home equity financing, the first consideration should be the type of financing – a home equity loan (HEL) or a home equity line of credit (HELO). Both serve the purpose of tapping your home equity, and both offer attractive interest rates; however, they function very differently. Here’s how to determine which is right for you.

How they differ

An HEL is, essentially, a fixed load with a fixed monthly payment to be paid over a fixed time period – much like your original mortgage except the amount of the loan is based on the amount of equity you have in your home. A typical HEL has a loan period of 10 or 15 years. Because the interest rate is guaranteed, it tends to be a bit higher than the interest rate applied to a HELOC (HELs can also offer an adjustable rate that fluctuates with the prime rate but has a guaranteed ceiling rate).

With a HELOC, a line of credit is established, again, based on the amount of equity in your home. Funds are withdrawn as you need them and you are only charged interest on the borrowed amount. In most cases, the minimum payment on a HELCO can be interest only. The interest rate is usually variable, which means it will rise and decline with the prime rate.

In both cases, the loan amount is established by a loan-to-value formula applied by the lender (typically up to 100 percent) which also considers other factors, such as your income, debt ratios, and your credit history. Also, the interest on both loans may be tax deductible depending on its use and other factors.

Which is right for you?

A HEL may be preferable if you need the funds for a specific, one-time purpose, such as remodeling, a car purchase, or some other lump-sum purchase. The advantage of a HEL is the fixed structure which enables you to keep the financing within your budget and doesn’t tempt you with the ability to keep borrowing as you can with a HELOC. The other advantage is, if you choose a fixed interest rate, your interest costs won’t increase if interest rates should rise. Financing with a HEL typically involves closing costs which are usually lower than the closing costs on a first mortgage.

A HELOC offer greater flexibility, and, initially, lower interest costs. Common uses of a HELCO are to fund college expenses over time, or an ongoing renovation project.  A HELOC can be fully repaid and available for use again if needed. The interest cost for a HELCO is typically lower than that for a HEL, but, because the interest rate is variable, you do assume the risk that interest costs might increase. Although there are usually no closing costs with a HELOC, they often charge an annual fee.

Ultimately, which type of home equity financing is right for you comes down to its purpose, the length of time you’ll need the loan, your outlook on interest rates, and your attitude about borrowing. These loans are secured by the equity in your home, so it’s important to borrow responsibly and use the funds in a way that can bring a positive return on your finances rather than simply for consumption.

*This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2014 Advisor Websites.