Updated: November 21, 2024
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Understanding the difference between a HELOC vs. a home equity loan is essential if you're considering tapping into your home's equity. While both let you borrow against your home's value, they work differently and can affect your finances in distinct ways.
We’ll discuss each option's unique features, including how you borrow, repay and meet lender requirements. By exploring these aspects, you'll gain the knowledge needed to choose the option that best suits your financial situation.
HELOCs offer flexible, revolving credit with variable interest rates, while home equity loans provide a lump sum with fixed payments and interest rates.
Get a HELOC for ongoing expenses or projects. Choose a home equity loan for large, one-time costs like home renovations.
Lenders typically look for a strong credit score and sufficient home equity when you apply for a HELOC or home equity loan.
Home equity lines of credit (HELOCs) and home equity loans can impact your finances differently. For example, a HELOC offers flexibility with variable interest rates and revolving credit, which can lead to fluctuating payments. In contrast, a home equity loan provides a lump sum with fixed payments, offering more predictability.
Explore the HELOC vs. home equity loan comparison table below to see how each option stacks up.
Dimensions | HELOC | Home Equity Loan |
|---|---|---|
Type of Credit | Revolving credit is similar to a credit card. You can borrow, repay and borrow again during the draw period. | One-time lump sum disbursement. |
Interest Rate | Variable interest rates can change over time, potentially affecting your monthly payments. | Fixed interest rate, ensuring consistent monthly payments over the life of the loan. |
Funds Disbursement | Funds are accessible as needed during the draw period, up to a pre-approved credit limit. | Full loan amount is disbursed at once, typically at closing, for immediate use. |
Repayment | Often, interest-only payments are made during the draw period, followed by principal and interest payments. | Fixed monthly payments covering both principal and interest from the start of the loan term. |
Loan Terms | The draw period typically lasts 5 to 10 years, followed by a repayment period of 10 to 20 years. | Repayment terms with fixed terms are usually five to 30 years, depending on the loan agreement. |
A home equity line of credit, or HELOC, is a flexible option for homeowners who need ongoing access to funds. Unlike a traditional loan, a HELOC functions like a credit card, allowing you to borrow against your home's equity as needed.
During the draw period, typically lasting 10 years, you can borrow, repay and borrow again up to your approved credit limit. After the draw period ends, the repayment period begins. During this time, you can no longer borrow additional funds and must start repaying what you've borrowed, usually with interest.
Since HELOCs often have variable interest rates, your payments can change over time, making it important to consider how these fluctuations might affect your budget. When you compare HELOC options, evaluating how the terms align with your financial goals is essential.
A home equity loan, often called a second mortgage, allows you to borrow against the equity you've built up in your home. The amount you can borrow depends on the difference between your home's current value and what you still owe on your primary mortgage. Once approved, you receive the funds all at once, making this loan ideal for covering significant, specific expenses like home renovations, debt consolidation or major purchases.
A home equity loan with a fixed interest rate ensures your monthly payments remain the same throughout the loan term, covering both interest and principal. This makes it easier to manage your budget, as you always know what you owe each month. This predictability is a key benefit to consider when making a home equity loan comparison.
Home equity is the portion of your home's value that you truly own. You can calculate it by deducting your mortgage balance from your home's market value. Your equity grows as you pay down your mortgage or if your home increases in value.
This equity can be used as collateral for loans, like HELOCs or home equity loans, giving you access to funds based on the amount of equity you've built up over time.
Both HELOCs and home equity loans allow you to tap into your home's equity, giving you access to funds at potentially lower interest rates than other borrowing options. However, the benefits of a HELOC vs. home equity loan can differ significantly, with one offering flexibility and the other providing payment stability.
Understanding these differences can help you choose the option that best aligns with your financial needs. Explore the table below to see how the benefits of each compare.
Benefits of a HELOC | Benefits of a Home Equity Loan |
|---|---|
Flexible Access to Funds: Borrow as needed during the draw period, and you can repay and borrow again up to your credit limit. | Fixed Interest Rate: Enjoy predictable monthly payments with a fixed interest rate, making it easier to budget for the life of the loan. |
Interest-Only Payments During Draw Period: Initially, you may only need to pay interest on the amount borrowed, reducing your monthly expenses. | Lump Sum Disbursement: This option allows you to receive the entire loan amount upfront, making it ideal for covering large, one-time expenses like home improvements or debt consolidation. |
Potentially Lower Initial Costs: HELOCs often have lower initial fees and costs than other types of loans, especially when you only borrow as needed. | Consistent Repayment Schedule: Fixed monthly payments allow you to plan your finances better, as you'll know exactly what you owe each month. |
Potential Tax Deductions: Interest paid on HELOCs may be tax-deductible if used for eligible home improvements, potentially lowering your tax liability. | Potential Tax Deductions: Interest paid on a home equity loan may also be tax-deductible if the loan is used for qualified home improvement projects. |
Both HELOCs and home equity loans carry the risk of losing your home if you can't repay. However, HELOCs may expose you to fluctuating interest rates, while home equity loans require immediate repayment of a lump sum. Understanding these risks can guide your choice. Explore the comparison between HELOCs and home equity loans below to see the drawbacks of each option.
Drawbacks of a HELOC | Drawbacks of a Home Equity Loan |
|---|---|
Variable Interest Rates: If market rates rise, your monthly payments can increase unexpectedly, making it harder to budget for future expenses. | Immediate Lump Sum Repayment: You must start repaying the full loan amount immediately, which can strain your finances if not carefully planned. |
Risk of Overborrowing: The revolving credit nature may lead to borrowing more than you can repay, increasing the risk of financial instability. | Less Flexibility: Once disbursed, you can only access additional funds if you take out another loan, limiting your financial flexibility. |
Payment Shock: When the draw period ends, monthly payments can rise sharply as you'll have to repay both principal and interest, causing financial strain. | Higher Initial Costs: Upfront fees and closing costs are often higher for this loan type than for other types, which can reduce the immediate benefit. |
Risk of Foreclosure: Falling behind on payments can lead to foreclosure, as your home serves as collateral for the loan. | Risk of Foreclosure: Like a HELOC, your home guarantees your home equity loan. You risk losing it if you can't keep up with the payments. |
Choosing between home equity loans and HELOCs is essential because each suits different financial situations. Selecting the wrong one could mean higher costs or payment schedules that don't align with your budget, leading to financial strain.
Remember, the best choice between home equity loans and HELOCs depends on your unique circumstances. Making an informed choice can help you leverage your home’s equity in the most beneficial way.
Knowing when a home equity loan is more suitable than a HELOC can help align your financial needs with the right borrowing option. It ensures you manage your debts effectively and avoid unnecessary financial stress. Scenarios where a home equity loan is a better choice include:
If you have a specific, significant expense, like a major home repair or a one-time medical bill, a home equity loan is ideal. They provide a lump sum, so you'll have the exact amount you need right away.
A home equity loan can be a smart move if you're consolidating debt, like paying off high-interest credit cards. It offers a one-time influx of cash without the temptation of an open line of credit, reducing the risk of accruing more debt.
A home equity loan with predictable monthly payments is suitable if you have a fixed income, such as a steady salary or retirement benefits. This ensures your payments don't fluctuate, making budgeting simpler and more reliable.
To build home equity faster, focus on making extra mortgage payments toward the principal whenever possible. Refinancing your mortgage to a shorter loan term can also accelerate equity growth, as can completing home improvements that increase your property’s value. Additionally, avoiding or minimizing new debt ensures more of your payments go toward building equity rather than covering interest or other obligations.
When applying for either a home equity loan or a HELOC, lenders have specific requirements you'll need to meet. They use these to determine whether or not you're a reliable borrower. Here's what they typically look for:
Equity
The equity in your home is foundational for these loans. It's calculated as the difference between your home's current market value and the remaining mortgage balance. Lenders often require you to have at least 15% to 20% equity, reducing their lending risk.
Credit Score
A good credit score, typically above 680, demonstrates your history of paying off debt and managing credit responsibly. The higher your score, the more favorable the loan terms you might receive, including lower interest rates.
Debt-to-Income Ratio (DTI)
Lenders look at your DTI to gauge your financial health. This figure compares your monthly debt obligations (like credit card payments and existing loans) to your income. A lower ratio, generally below 43%, indicates you're not overly burdened by debt and can handle additional loan payments.
Home Appraisal
This is an evaluation by a professional to estimate your home's current value, which determines the maximum amount you can borrow. The appraisal considers factors like location, size, condition and recent sales of similar properties.
Income and Employment
Having a reliable income and a stable job reassures lenders that you can keep up with repayments. They typically verify your income through pay stubs, tax returns and employment history. Consistent employment, preferably for at least two years in the same job or field, is often looked upon favorably.
When you compare HELOCs and home equity loans, it’s natural to have questions about which option suits you best. The way these two financing options work can be confusing. We’ve answered some common questions so you can better understand how each could impact your finances.
It depends on your financial needs. A HELOC is better for ongoing expenses, while a home equity loan is ideal for a one-time, significant expense.
A HELOC is a revolving line of credit against your home’s equity, while a conventional loan is a lump sum with fixed payments. HELOCs typically have variable rates, while conventional loans usually offer fixed rates.
Yes, comparing HELOC lenders can help you find better interest rates, terms and fees, which can save you money over the life of the loan.
Choose a home equity loan if you need a lump sum for a specific purpose. Opt for a HELOC if you need flexible access to funds over time.
Not comparing HELOC options could result in higher interest rates, unfavorable terms and additional fees, which may cost you more in the long run.
Yes, you can have both if you have sufficient equity in your home, but this increases your debt and the risk to your property.
Yes, depending on your financial needs and current market conditions, you can refinance a home equity loan into a HELOC or vice versa.
A home equity loan typically provides funds faster since it’s a lump sum disbursement, while a HELOC requires setting up a line of credit. But in terms of approval, both generally have similar processing times, ranging from a couple of weeks to a few months.
About Zachary Romeo, CBCA
Zachary Romeo is a certified Commercial Banking and Credit Analyst (CBCA), and the Head of Loans and Banking at MoneyGeek. Previously, he led production teams for some of the largest online informational resources in higher education, with over 13 years of experience in editorial production.
Romeo has a bachelor's degree in biological engineering from Cornell University. He geeks out on minimizing personal debt and helping others do the same through people-first content.
