A Line of Credit (LOC) and a Home Equity Loan are both forms of borrowing that use your home’s equity as collateral. A Line of Credit is a revolving credit account that allows you to borrow money up to a pre-determined limit. However, a Home Equity Loan is a type of loan that allows homeowners to borrow money using the equity they have built up in their home as collateral.
What is Line of Credit?
A Line of Credit (LOC), often referred to as a revolving credit facility, is a flexible borrowing arrangement that allows individuals to access funds up to a pre-determined limit. The key characteristic of a LOC is its revolving nature, which means borrowers can withdraw funds as needed, repay them, and then reuse the credit line. In India, banks and financial institutions offer lines of credit to eligible individuals based on factors such as creditworthiness, income stability, and existing debt obligations.
Key Features of Line of Credit:
- Flexibility: Borrowers have the flexibility to withdraw funds multiple times up to their approved credit limit. It is similar to a credit card but with potentially lower interest rates.
- Revolving Credit: As payments are made towards the outstanding balance, the available credit is replenished, allowing for ongoing access to funds without requiring re-application.
- Interest on Utilized Amount: Interest is charged only on the amount withdrawn and utilized, not on the entire credit limit.
- Variable Interest Rates: Interest rates on lines of credit can be variable, tied to a benchmark rate, like the repo rate, which means monthly payments can fluctuate.
- Usage: Lines of Credit can be used for various purposes such as home renovations, education expenses, or unforeseen emergencies.
What is Home Equity Loan?
A Home Equity Loan (HEL), also known as a Mortgage Loan Against Property (LAP) in India, is a secured loan that allows homeowners to borrow against the equity they have built in their residential property. Equity is the difference between the market value of the property and the outstanding balance on any existing mortgages or loans secured against the property. Home Equity Loans provide borrowers with a lump sum amount that is repaid over a fixed term with regular installment payments.
Key Features of Home Equity Loan:
- Secured by Property: Home Equity Loans are secured by the borrower’s residential property, which serves as collateral for the loan.
- Fixed Loan Amount: Borrowers receive a lump sum amount based on the available equity in their property at the time of loan application.
- Fixed Interest Rates: Interest rates on home equity loans are typically fixed for the duration of the loan term, providing predictability in monthly payments.
- Structured Repayment: Borrowers repay the loan amount and interest over a pre-determined period through regular installment payments.
- Purpose-Oriented: Home Equity Loans are often used for specific purposes such as funding major expenses, like higher education, wedding expenses, or debt consolidation.
Difference between Line of Credit and Home Equity Loan
|
Basis |
Line of Credit |
Home Equity Loan |
|---|---|---|
|
Meaning |
It is a revolving credit account that allows you to borrow money up to a pre-determined limit. |
It is a type of loan that allows homeowners to borrow money using the equity they have built up in their home as collateral. |
|
Nature of Credit |
It is a revolving credit facility. |
It involves lump sum loan. |
|
Security |
Line of Credit is generally unsecured or is partially secured. |
Home Equity Loan is secured by residential property. |
|
Interest Rates |
The interest rate varies in case of line of credit. |
The interest rate of home equity loan is usually fixed. |
|
Interest Charges |
Interest is paid only on the amount utilized. |
Interest is charged on the entire loan amount disbursed. |
|
Credit Limit |
One can borrow up to a pre-determined credit limit. |
One can borrow a lump sum based on available equity in the property. |
|
Flexibility in Repayment |
Line of Credit has flexible repayment structure. |
The borrower has to pay fixed installments over a set term. |
|
Security Risk |
The risk of asset repossession is less. |
There is higher risk in home equity loan due to property serving as collateral. |
|
Suitability |
It is suitable for varying or unpredictable expenses. |
It is suitable for one-time expenses with fixed funding requirements. |
Line of Credit and Home Equity Loan – FAQs
How do I qualify for a home equity loan?
To qualify for a home equity loan, you typically need to have sufficient equity in your home and a good credit score. Lenders will also consider your income and ability to repay the loan.
Are the interest payments tax-deductible?
In some cases, the interest paid on a home equity loan or line of credit may be tax-deductible if the funds are used for home improvements. It’s advisable to consult a tax advisor for specific guidance.
What are the risks of a home equity loan?
The main risk of a home equity loan is that your home serves as collateral. If you fail to repay the loan, you could potentially lose your home through foreclosure.
How do I choose between a line of credit and a home equity loan?
The choice depends on your financial needs and preferences. A line of credit offers flexibility and ongoing access to funds, while a home equity loan provides a lump sum for specific purposes.
How does borrowing against home equity affect my overall financial picture?
Borrowing against home equity can impact your overall financial situation by increasing your debt-to-equity ratio. It’s important to borrow responsibly and ensure you can afford the monthly payments.