Lump Sum or Line of Credit, Picking One to Work for You
So you want to borrow money against your home's equity, no problem. You just
need to decide how you want it-cash or credit. The both work equally well.
They both have their advantages and disadvantages.
Home equity loans come in a variety of shapes and sizes. The big decision is
whether you want it in one big lump-sum or would rather tap into a line of
credit when you need to. Here is a brief overview of each and some things to
think about before signing that loan:
A fixed-rate loan or lump-sum payment loan is like a second mortgage. You
have to go through a similar loan process and you will be required to notify
your lender if you ever put the house up for sale. And you will have to pay
back the loan in full when you actually sell the home.
Lump sum loans are a good idea if you need a large amount of cash all at
once. It pays in a lump sum and has an amortized payment plan over a set
period of time. The benefits of this type of loan is knowing how much you
will have and when. It also helps you plan your payback budget a little
The caveat is that you cannot tap into your equity at will. You have to plan
ahead and follow procedures. It takes forethought and planning to not get
caught with a shortfall of cash when using this method. Once you get your
lump-sum it is quite difficult to get any more.
Line of Credit
A line of credit is much more flexible in its terms. You begin by arranging
an amount that you can borrow against. The lender sets a top limit of money
you can borrow. It then sits in a credit fund against which you can draw
You spend your line of credit, as you need to, when you need to. It's as easy
as writing a check.
You pay it back in a set period of time with interest. The good news is that
you only pay interest on the money you borrow. This is a good idea if you are
going to be borrowing irregular amounts of money over time for college or
Home-equity lines typically expire long before a 30-year mortgage, although
if you look hard enough you can find some that expire only when you sell.
Generally, the loan is divided into a "draw" period and a "payback" period.
The draw period is the amount of time during which you can draw money at
will. The payback is pretty self-evident. This is when you have to start
paying on that loan. As you pay back the loan, your credit is restored.
The terms of a line of credit are spelled out in the contract, including what
happens when the draw period ends. Be sure to pay close attention to the time
frame for the draw and payback. Also keep an eye out for minimum draws and
any other restrictions.
Source: Based on information from Kiplinger Magazine.