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:

Lump Sum

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 better.

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 payments.

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 improvements.

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.