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Home equity
HELOC vs. Home Equity Loan, What’s the Difference?
What you'll learn: Lines of credit vs. loan: How you receive the cash, interest rate, and repayment
EXPECTED READ TIME:7 MINUTES
Updated November 8, 2023
Do you need cash to tackle home improvements, pay down debt, or fund other expenses? Wondering if you can pull equity out of your home without refinancing? The answer is: Absolutely. Home equity loans and lines of credit are two popular ways to access equity for a variety of needs. In this article, we’ll cover how they differ, their pros and cons, and other factors to consider so you can choose the best option for you.
Home equity loan defined
A home equity loan is a loan for a fixed amount of money that you access all at once, usually with a fixed interest rate. You secure this loan type through the equity in your home.
HELOC defined
A home equity line of credit (HELOC) is a revolving line of credit based on the equity you have in your home. Similar to a credit card, your lender sets a limit and you can access the funds if and when you need them during the draw period.
How are home equity loans and HELOCs similar?
If you’ve built up enough equity in your home and have favorable credit, you can likely leverage either of these loan options. It’s easy to confuse these loan types because they have some similarities:
- You must meet certain equity and credit standards. Your lender will calculate your loan-to-value ratio and run a credit check before approving the loan.
- Your home is used as collateral. Both HELOCs and home equity loans are considered second mortgages. If you can’t keep up with payments, there is risk of foreclosure on your property.
- Rates may be lower than other loan types. When your home is secured as collateral, interest rates are often lower than unsecured loans such as personal loans or credit cards.
- There are no rules about what HELOC and home equity loan funds can be used for. Although it’s recommended to use your equity to add value to your home or improve your finances, there are no limitations in place for how to use the cash.
HELOC vs. home equity loan: What are the differences?
HELOCs and home equity loans have many important differences that make them well suited for certain situations and less appealing for others. Here are three key differences:
1. How you receive your funds
Does it matter when and how you’ll get your cash? Consider if you need it all right away or prefer more flexibility.
- Home Equity Loan – With a home equity loan, you’ll receive a lump sum of funds at loan closing. This can be more useful if you have a specific, big project to tackle and you need the funds all at once.
- HELOC – You can access funds when you need them over a set period of time, typically 10 years. Depending on your lender’s offerings, you may be able to use HELOC funds by paying with checks, a card, or account transfer.
2. The type of interest rate
Do you appreciate knowing in advance what your payments will be, or are you comfortable with fluctuations? A fixed or variable rate will determine exactly what your payments look like.
- Home Equity Loan – Typically, you have a fixed interest rate over the life of the loan. That means, you’ll know your monthly payment and the total cost of the loan up front.
- HELOC – The rate will be variable, meaning it can go up or down depending on the market. Despite the uncertainty, a HELOC’s interest rate is often lower than other loan types.
3. How you’ll repay your loan
What’s more important: consistency or flexibility?
- Home Equity Loan – Like a regular mortgage, home equity loans need to be repaid over a set period of time with a defined payment schedule.
- HELOC – Once you start to access your available HELOC funds, you only need to pay the minimum payment every month until after the draw period is complete. Then, you may be required to pay the balance all at once or you may be allowed to repay it over a specified time period.
Home equity loans vs. lines of credit
Here’s a recap of some of the most important similarities and differences.
|
|
Home Equity Loan |
HELOC |
|---|---|---|
|
Access to cash at closing: |
Yes – lump sum |
Yes – line of credit |
|
Home used as collateral: |
Yes |
Yes |
|
Interest rate: |
Fixed (Though some lenders may offer variable options.) |
Variable |
|
Repayment schedule: |
Defined payments |
Variable payments |
|
Funds can be used for: |
Anything |
Anything |
Pros and cons
As you’ve learned, there are pros and cons to each loan type. Following are the potential advantages and disadvantages of home equity loans vs. HELOCs.
|
Home Equity Loan Advantages |
Home Equity Loan Disadvantages |
|---|---|
|
Get an up-front lump sum of cash at closing |
Often has a higher interest rate than cash-outs and HELOCs |
|
Fixed-interest rate and monthly payments (Some lenders may offer variable-rate options) |
Pay interest on the whole amount whether or not you use it all |
|
Does not impact your first mortgage if you want to keep those terms |
Adds a second mortgage to manage |
|
Shorter terms can mean less interest paid |
Shorter terms can mean higher monthly payments |
|
HELOC Advantages |
HELOC Disadvantages |
|---|---|
|
Take only as much as you need, as you need it, during the draw period |
Variable interest rate may increase with the market |
|
Only pay interest on the amount you draw |
Fluctuating monthly payments can make it hard to budget |
|
Low introductory interest rate |
Revolving line of credit can be tempting to use for unintended purposes |
|
Acts like a credit card, but often with a higher balance and lower interest rate |
Adds a second mortgage to manage |
Which is better: A home equity loan or a HELOC?
You’ve seen the differences. You know the pros and cons. So how do you know which is better? Here are two examples to illustrate just how you could make the choice.
Scenario 1: Hiring a contractor
Say you want to put an addition on your home or upgrade your kitchen. If you have a contractor who will be managing the job, you know what the costs will be and how quickly you’ll need the funds. Therefore, a home equity loan might be the better choice, because you will have a fixed payment every month, and you’ll have access to all the needed funds up front.
Scenario 2: DIY home improvements
Now, imagine you want to upgrade your home over time. Perhaps you’re a do-it-yourself type of person or would rather upgrade part of the home this year, see how things go, and maybe make a few more upgrades down the road. With this example, a HELOC is likely the better choice because you don’t need the funds all at once and may change your mind on upgrades in the future.
|
If you are… |
Then you may choose… |
|---|---|
|
Working with a contractor and know the total costs at the beginning of the project: |
Home Equity Loan |
|
Making home improvements a little at a time and don’t know the full costs up-front: |
HELOC |
|
Planning to make a large, one-time payment for an investment property, wedding expenses, or to consolidate debt: |
Home Equity Loan |
|
Attending college and will make intermittent payments for tuition, housing, and meal plans over the next few years: |
HELOC |
Home equity loan vs. line of credit: What’s best for you?
We know you want to make the right choice when borrowing against your home. The following questions can help you make a decision:
- How and when do you want to receive the funds?
- Do you want a fixed or variable rate?
- What type of repayment schedule do you prefer?
If you need help deciding, or are ready to move forward, a mortgage loan officer can help you through the HELOC or home equity loan process steps.
