Home Equity Line Of Credit (HELOC) Vs. Home Equity Loan: Comparison Guide

Homeownership gives you the opportunity to build equity over time. Once you’ve built a substantial amount of equity in your home, you can borrow against it to finance a home improvement project or pay down higher-interest debt. Many borrowers do this by taking out a home equity line of credit (HELOC) or a home equity loan.

HELOCs and home equity loans both allow you to tap into your home’s equity, though they do it in slightly different ways. Let’s look at some of the main differences between a HELOC versus a home equity loan and how to determine which is right for your situation.

Defining HELOCs Vs. Home Equity Loans

Understanding how HELOCs and home equity loans work will help you determine which is right for you. Here’s an overview of a HELOC versus a home equity loan.

HELOC Definition

A home equity line of credit (HELOC) is an open line of credit that you can draw from on an as-needed basis. A HELOC includes a draw period and a repayment period. During the draw period – which typically lasts between 5 – 10 years – you can borrow up to your credit limit. As you pay down the principal, you can borrow up to the full credit limit again.

Most lenders only require interest payments during the draw period. Once the repayment period begins, you must pay off the outstanding balance, which includes interest and principal payments. Depending on your lender, the repayment period can last up to 20 years.

Home Equity Loan Definition

A home equity loan is often referred to as a second mortgage since it’s a loan you take out using the equity in your home as collateral. Unlike a HELOC, you’ll receive the funds as a lump sum payment and will begin repaying the loan immediately.

Home equity loans usually come with fixed interest rates, so your monthly payments won’t change. The repayment terms can vary but typically are either 10 or 20 years, depending on your lender. Longer repayment terms will make your monthly payments more affordable, but you will pay more in interest over the life of the loan.

What Do HELOCs And Home Equity Loans Have In Common?

Here are the biggest similarities between a home equity loan versus a HELOC:

• You can use the funds in similar ways: You can use HELOCs and home equity loans for major purchases like debt consolidation and home improvements.
• Your home becomes collateral: HELOCs and home equity loans are secured loans, and your home is used as collateral. That means if you’re unable to repay the loan, your lender could foreclose on your house.
• You’ll have to pay closing costs: Both lending options come with closing costs, which increases the total borrowing amount.
• You can borrow up to the same amount of your home’s value: When you take out a HELOC or home equity loan, you can typically borrow up to 80% of your home’s value minus whatever you still owe on your mortgage.
• Borrower requirements are similar: The financial and appraisal requirements are fairly similar for home equity loans and HELOCs.

Key Differences Between HELOCs And Home Equity Loans

Here are some of the key differences between a line of credit vs. a home equity loan:

Benefits And Drawbacks Of Home Equity Loan Vs. HELOC

If you want to finance a home improvement project, a HELOC or home equity loan can help you do it. Let’s look at some of the pros and cons of HELOCs and home equity loans.

Benefits Of Home Equity Lines Of Credit

• Only spend the amount you need: When you take out a HELOC, you’re given access to a line of credit. However, you don’t have to spend up to the full credit limit and can only borrow the amount you need.
• Only repay what you spend: You’ll only have to repay the amount you borrow, not the full amount issued.
• Possibly save money on interest: Since interest is only charged on the amount you borrow and not the full credit line, you could save money on interest charges because you borrowed less money.

Drawbacks Of Home Equity Lines Of Credit

• Risk of losing your home: Since you’re using your home as collateral for the HELOC, you risk losing it if you’re unable to repay the loan.
• Unpredictable monthly payments: HELOCs come with variable interest rates, which can lead to unpredictable monthly payments over the repayment period.
• Additional fees: HELOCs may come with additional fees, like an annual fee and a prepayment penalty if you pay off the loan early.
• Lenders could freeze or reduce credit limit: If the lender suspects you might have trouble repaying your HELOC, they could reduce or freeze your credit limit during the draw period.
• Possibility of overspending: If your line of credit is much higher than what you actually need, there could be a temptation to overspend.
• Benefits Of Home Equity Loans
• Predictable monthly payments: Home equity loans have fixed interest rates, which provide predictable monthly payments.
• Lower interest rates: The rates for home equity loans are almost always lower than financing options like credit cards and personal loans.
• Potential tax benefits: The interest paid on home equity loans may be tax-deductible if you used the funds for certain home improvements.

Drawbacks Of Home Equity Loans

• Risk of losing your home: Since you’re using your home as collateral, you risk losing it if you’re unable to repay the loan.
• Risk of over-borrowing: The lump sum payment could be much more than what you need, which could lead to overspending or paying interest on funds you don’t end up using.
• Risk of under-borrowing: Alternatively, the loan amount could be less than what you need, which would require you to borrow additional funds.
• Potential for negative equity: There’s always the potential for negative equity, which means you owe more on your mortgage than the home is worth.

FAQs: Home Equity Line Of Credit Vs. Home Equity Loan

What’s the difference between a HELOC vs. home equity loan rates?

The main difference is that a HELOC usually comes with variable interest rates and a home equity loan has fixed rates. That means your monthly payments will be more consistent and predictable with a home equity loan. With a HELOC, your payments could go up or down depending on market conditions. Plus, a HELOC allows you to borrow money when you want, versus a one-time loan, but usually comes with additional fees.

When should I choose a HELOC over a home equity loan?

A HELOC is best for borrowers who need access to funds over an extended period of time. For example, if you’re financing a home improvement project and don’t know the full extent of the costs, a HELOC may be a good choice.

When should I choose a home equity loan over a HELOC?

A home equity loan is a good choice for borrowers who know exactly how much they need to borrow. For example, home equity loans are a good option for consolidating debt since you’ll save on interest charges. A home equity loan is also a good option if you need to finance a home renovation and know how much it’s going to cost.

What are some alternatives to HELOCs or home equity loans?

A cash-out refinance is a popular alternative to taking out a HELOC or home equity loan. This involves refinancing your home for more than it’s currently worth and receiving the difference in cash. However, this option is best if you can refinance your loan and receive better terms and rates than you currently have.

How do I get a home equity loan or line of credit?

To qualify for either, you must have at least 15% to 20% equity in your home. You’ll also need a good credit score and low debt-to-income (DTI) ratio. You can contact your lender to see if you’re a good candidate for a home equity loan or HELOC.

Will I get the money faster with a home equity loan or HELOC?

A HELOC typically comes with faster funding timelines than a home equity loan. However, the exact timeline will depend on your lender, the amount borrowed, your credit score and how much equity you’ve built in your home.

The Bottom Line

Home equity loans and HELOCs both let you borrow against the equity in your home, but they aren’t the same thing. When you take out a home equity loan, you’ll receive a one-time, lump-sum payment, whereas a HELOC gives you access to an ongoing line of credit. If you’re ready to apply for a home equity loan, you can get started with Rocket Mortgage^® today.