Home Equity Debt Consolidation Loan Options: HEL vs. HELOC

If you are trying to consolidate your debt, and you own a home, some financial advisors may suggest using a home equity debt consolidation loan.  This simply means that you will be borrowing against your home’s equity; the equity is the difference between your home’s current value and the amount of money you still owe on your mortgage.  Most loans fall into two categories – a home equity loan, known as a HEL loan, or a home equity line of credit, known as a HELOC loan.  These two types of loans both are based on your home equity value, but each works a bit differently from the other. 

About HEL Loans

Sometimes HEL loans are also called “second mortgages,” because they work similar to regular mortgages.  With HEL loans, the borrower receives the full amount of their loan up front, and must make monthly payments to pay back the debt.  Most HEL loans have a shorter term than most regular mortgages.  Also, with most HEL loans, you are unable to take borrower more than the equity value of your home.  In some states, you may be further restricted toa maximum 80% of your equity.  There are some lenders that will allow you to borrow more than your home's equity value, but doing so could cause you problems if you want to sell your home and your HEL loan is not paid off.

Most HEL loans carry a fixed interest rate.  You are not in any danger of your loan interest rate suddenly going up.  You may also be able to deduct the interest on an HEL loan on your income tax returns. Keep in mind that HEL interest rates tend to be slightly higher than regular first mortgage rates.  Additionally, many HEL loans have odd payment terms.  For example, the loan may be amortized for 30 years, but due and payable in 15 years.

What About HELOC Loans?

A HELOC loan works differently from an HEL because a HELOC works more like a credit card.  You can choose to accept a lump sum of value, or the lender instead will open a line of credit for the unused portion of your loan.  The borrower is provided with a quasi-credit card or checks which allows them to withdraw money from their line.  The borrower will be required to make his/her monthly payments on the used proceeds that were used.  They can continue to withdraw money back and pay it back until specified per loan terms.  Many times a HELOC loan is interest only, which allows you low monthly payments.

There are two disadvantages to an HELOC.  Instead of a fixed interest rate, most HELOCs carry adjustable interest rates, which means that your interest rate can increase.  Also, most HELOC loans only allow a limited withdrawal period. Most lenders have designated either five or ten years as withdrawal periods and the remainder of the loan term (usually 20 to 25 years) is usually only a repayment period.

It is important to remember that with both HELS and HELOCS, the collateral on the loan would be your own home.  If you default on your loans, a lender can foreclosure on your home.  Be sure to keep a careful eye on your finances if you choose either of these home equity consolidation loan options.