Home Equity Loan or Line of Credit: Five Questions to Answer

Unexpected expenses, college tuitions, medical bills and other hardships can prompt home owners to turn to a home equity loan or line of credit. Having access to the equity in your home can be a lifesaver in a pinch, and even if you've already decided to tap the equity, you still have decisions to make. Some people will do better with a home equity loan, while others would fair better with a line of credit. Here are five questions to help you choose.

Q1: Lump Sum or Installments?

If the expense for which you are going to tap equity is a large one-time bill that needs to be paid, a home equity loan is probably the best way to go. You can borrow just as much as you need, pay the bill, then start to repay the loan without having to worry about revolving credit. If, however, this new expense in your life will be continual for several months, or if you are going to make installment payments, a line of credit would be prudent. This will allow you to pay back the money as you spend it rather than drawing on a large lump sum.

Q2: Long-Term or Short-Term?

The length of your investment should also play a part when deciding between a home equity loan and a line of credit. If the expense will be justified with a long-term possession, such as a car or a brand new kitchen, a home equity loan is usually the way to go. If, however, the expense will only last for a short period, such as a Bar Mitzvahs for your child or a vacation to Aruba, a line of credit would probably be better.

Q3: Large or Small Monthly Payments?

If you have a sizable income and you aren't worried about paying back the money you borrow, a home equity loan is probably better than a loan. It will allow you to pay off the balance faster on interest and principle and won't drag out the obligation. If, however, you need smaller, more manageable monthly payments, a home equity line of credit is usually the better choice. It will allow you to pay only the interest you accrue until you decide to pay it off, and will be less of a financial burden on a monthly basis.

Q4: Smart or Foolish with Money?