Home Equity Loan vs. Line of Credit Pros and Cons

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Updated: November 19, 2024

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A home equity loan provides a lump sum with a fixed interest rate, making it ideal for large, predictable expenses like renovations. A line of credit offers flexibility, allowing you to borrow as needed, which is great for ongoing costs like college tuition. However, both carry the same risk — your home is collateral, and missed payments could lead to foreclosure.

Understanding the pros and cons of home equity loans vs. lines of credit can help you make better financial decisions. We’ll break down the benefits and risks of each to help you choose wisely.

Key Takeaways

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Home equity loans offer predictable payments with fixed interest rates but have higher closing costs and a long-term commitment.

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Home equity lines of credit (HELOCs) provide flexible borrowing, but variable interest rates can increase payments and lead to overspending if not managed carefully.

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Home equity loans are better for large, one-time expenses, while HELOCs work well for ongoing or unpredictable costs like home repairs or education.

Home Equity Loan vs. HELOC: What’s the Difference?

The key difference between a home equity loan vs. a line of credit is how the funds are accessed and repaid. A home equity loan gives you a lump sum with fixed monthly payments, making it ideal for large one-time expenses. A home equity line of credit (HELOC) offers flexibility, allowing you to borrow as needed with variable interest, making it more suitable for ongoing or unpredictable costs.

Below is a detailed comparison to help you understand the differences:

Comparison Area
Home Equity Loan
Line of Credit (HELOC)

Access to funds

One-time payout with no additional borrowing

Reusable credit line during the draw period, allowing multiple withdrawals

Interest rate

Fixed interest rate for the life of the loan

Variable interest rate, which may fluctuate over time

Repayment

Fixed monthly payments over a set term

Typically interest-only payments during the draw period, with full repayment required during the repayment phase

Best for

Large, one-time expenses like home remodel and debt consolidation

Ongoing or unpredictable expenses like home repairs and tuition

Loan term

Fixed loan term, usually five–30 years

Draw period (usually five–10 years), followed by a repayment period (10–20 years)

Home Equity Loan Pros and Cons

A home equity loan can be a smart option for homeowners who need a large, one-time payment, like for major renovations or debt consolidation. However, it has its trade-offs. Below, we explore the pros and cons of home equity loans so you know what to expect.

Home Equity Loans

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Pros
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Cons
  • Foreclosure risk for your home if you default on payments.
  • High closing costs, similar to those of a traditional mortgage.
  • Borrowing inflexibility: Once you receive the lump sum, you can’t borrow more without taking a new loan.
  • Long-term commitment: Home equity loans often have long repayment periods, tying you to the debt for many years.
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HOW A FIXED LOAN CAN BE MORE FLEXIBLE THAN A LINE OF CREDIT

A line of credit may seem more flexible initially, but a home equity loan’s fixed payments can provide stability that leads to long-term financial flexibility. For example, with fixed monthly payments, you can plan your budget more accurately, especially if your income is steady or you prefer a predictable financial routine.

A fixed-rate loan protects you from increasing costs if interest rates rise. This can free up extra cash for other priorities, such as saving for retirement or handling unexpected expenses without worrying about fluctuating payments.

Line of Credit Pros and Cons

A line of credit offers flexibility by allowing you to borrow as needed, but it comes with certain risks. Understanding the line of credit pros and cons can help clarify when this option might best suit your financial situation. Here's a list of the advantages and drawbacks of using a line of credit:

Lines of Credit

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Pros
  • Flexibility: Borrow only what you need when needed.
  • Pay interest only on what you use: Interest accrues only on the amount you borrow, not the entire credit limit.
  • Reusable credit: You can borrow again once you repay. You don’t need to reapply for a new loan.
  • Lower initial costs: HELOCs often have lower closing costs than home equity loans.
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Cons
  • Variable interest rates lead to higher payments over time.
  • Potential for overspending: Easy access to funds can make it tempting to borrow more than necessary.
  • Unpredictable monthly payments that vary depending on how much you borrow and interest rate changes.
  • Foreclosure risk: Missed payments can lead to foreclosure.
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WHY FLEXIBILITY CAN BE A DOUBLE-EDGED SWORD

The flexibility of a HELOC can be appealing but can also lead to overspending. With easy access to funds, you might borrow for non-essentials, like vacations or luxury upgrades, instead of sticking to necessary expenses.

This can quickly add up, especially if interest rates rise or your financial situation changes. Relying too heavily on available credit without careful planning may create long-term financial stress. The seemingly helpful flexibility can become a burden if not managed wisely, leaving you with more debt than expected.

Which Option Is Right for You?

When deciding between a home equity loan vs. a line of credit, think beyond your immediate financial needs. Economic factors like interest rates, inflation and housing market conditions determine the more advantageous option. Here are some questions to consider as you weigh your options.

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    How do economic conditions affect your choice?

    In a rising interest rate environment, a fixed-rate home equity loan offers predictability and protects you from rising costs. When rates are low, a HELOC with variable rates may provide cheaper access to funds. Regional housing market trends can also affect borrowing limits based on your home’s value.

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    How much risk are you willing to take?

    A HELOC comes with more uncertainty due to variable interest rates, which could increase your payments. If you prefer a safer, more stable option, a home equity loan’s fixed rate and payments might suit you better.

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    Do you have a plan for repaying what you borrow?

    A home equity loan has a set repayment plan from the start, while a HELOC offers flexibility. However, this flexibility can lead to financial strain if you’re not careful. If you're unsure about your future income or cash flow, a fixed loan may help you stay on track.

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    How long do you plan to stay in your home?

    If you expect to sell your home within a few years, a HELOC can be a better fit, as it allows you to pay interest only on what you borrow. A home equity loan’s longer commitment may not make sense if you plan to move soon.

The Psychological Costs of Borrowing Against Home Equity

Borrowing against your home's equity can have unexpected emotional and psychological effects. The pros and cons of home equity loans and HELOCs go beyond your finances, impacting your sense of security and peace of mind. Below, we explore the emotional consequences homeowners might face when using their homes as collateral.

  1. 1
    Stress from risking your home

    Using your home as collateral can create ongoing anxiety, especially if your income is unstable. Even if you're confident in your financial plan, the thought of losing your home due to missed payments may weigh heavily.

  2. 2
    Sense of reduced security

    Borrowing against your home’s equity can make you feel less secure about your future. If you've spent years building equity, tapping into it could feel like a setback, reducing your long-term financial safety net.

  3. 3
    Pressure to avoid additional debt

    The emotional burden of owing more debt can lead to financial caution in other areas of your life. For example, you might avoid necessary expenses or delay investments out of fear of increasing your debt load.

  4. 4
    Regret over lost home equity

    Some homeowners regret using their home equity for non-essential purchases, like vacations or luxury items. Watching their equity decrease for short-term benefits can lead to second-guessing the decision and a sense of guilt over the lost financial value.

Home Equity Loan and HELOC Fees: What You Need to Know

When taking out a home equity loan or a home equity line of credit (HELOC), account for more than just interest rates. Both options have additional fees and considerations that can affect the total borrowing cost. Below are some common financial factors and tips for managing them effectively.

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    Closing costs

    Home equity loans and HELOCs often include closing costs, ranging from 2% to 5% of the loan amount. These can include appraisal fees, title insurance and attorney fees. To manage this, ask if your lender offers no-closing-cost options or if you can roll the fees into the loan.

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    Annual maintenance fees

    Some HELOCs charge an annual fee to keep the line of credit open, even if you don’t use it. Check with your lender for any promotions that might waive this fee.

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    Early closure fees

    Lenders may charge a fee if you pay off your loan or HELOC early. Always check your terms to understand any prepayment penalties before deciding on early repayment.

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    Inactivity fees

    HELOCs may include fees if the credit line isn’t used over a certain period. Borrowing a small amount periodically can keep the account active and avoid these charges.

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    Opportunity cost

    Tapping into your home’s equity means tying up funds that could be used elsewhere, such as in investments or emergencies. Consider whether using your home equity is the best option for your long-term financial goals.

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    Insurance requirements

    Depending on your home's location, some lenders may require additional insurance, such as flood or hazard coverage. For example, if you live in a flood zone, you might need to purchase flood insurance, which can add an extra ongoing cost to your loan.

FAQ: Home Equity Loan vs. Line of Credit Pros and Cons

When considering a home equity loan or HELOC, understand how they work and the risks involved. Below are answers to common questions that can help clarify the differences and what to expect from each option.

What’s the difference between a home equity loan and a HELOC?
How does interest work on a HELOC compared to a home equity loan?
Can I lose my home if I default on a home equity loan or HELOC?
What are the typical closing costs for a home equity loan or line of credit?
What are the risks of using a HELOC for large ongoing expenses?
How do rising interest rates impact a home equity loan vs. a line of credit?
How much can I borrow with a home equity loan or HELOC?

About Zachary Romeo, CBCA

Zachary Romeo, CBCA headshot

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.

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