How does a home equity loan work?

For homeowners that have a specific need or project to pay for, a home equity loan is an option to accomplish your financial goals. There are two ways to use home equity—as a term loan or as a line of credit.

Traditionally written as a second mortgage, a home equity term loan is a similar loan where your lender uses the equity you have in your home as collateral. Loan rates are typically lower for shorter term loans; however, payments will be higher. There are many payment and term options available to correspond with your individual financial plan.

Jeremy Seldon, vice president of Residential Real Estate for Thrivent Credit Union, says this may be a good option if you are planning a big home improvement project or are in need of a specific amount of money to be paid over time.

Think of a home equity line of credit, or HELOC, like a credit card. It’s a revolving line of credit that you can use, pay off and reuse. That makes it ideal for a short-term need or an additional source of emergency reserve.

With a HELOC, you’ll only pay interest each month, plus any principal you are able to pay down. The remaining balance at the end of the loan’s term will be paid off as a balloon payment or refinanced. HELOCs can be more flexible, Seldon says, and are most likely used for short-term financial needs.

It’s about your preference, says Karen Gajeski, senior vice president of Mortgage Banking for Thrivent Credit Union. The differences come down to when you need your money, how much debt you’d like to take on, and what payments you’d like to make. The interest rates can be very similar between the two, Gajeski says, but rates with HELOCs can adjust over the term of the loan based on market conditions, whereas term loans typically have a fixed rate.

“If you’re using [the loan] to make home improvements, then pay it down, and use it again for another reason, HELOCs are great,” she says. “If there’s something you need to purchase, and pay off over a longer time frame, then term is your solution.”

Learn more about home equity loans and other services at Thrivent Credit Union.