What’s the difference between a HELOC and a home equity loan?

If you’re like millions of other Americans, you’re probably sitting on more home equity than you think — and that number generally goes up every year as your home value rises and your mortgage balance decreases. The equity in your home is more than just a line on your real estate portfolio; it also has many advantages if you need to borrow money.  

‍

Home equity loans and home equity lines of credit (HELOCs) are two of the most common tools that people use to tap into their home equity. There are many similarities between these options, but there are many distinctions, too — and that may impact whether one is better for you than its sibling. We’ll cover the difference between home equity loans and lines of credit to help you choose.

HELOC vs home equity loan

Most people are aware that home equity loans are offered as a lump sum, while HELOCs are more akin to credit cards that allow you to borrow money as you need over a longer time period. That’s true, but we’ll help you go further by putting it into perspective. 

Similarities between a home equity loan and line of credit

Borrowing funds can help you afford a better life, but it also comes with certain other risks and rewards. First, consider whether these general attributes of HELOCs and home equity loans work for you:

• Lien on home: Lenders will place a lien on your home alongside your mortgage lien, potentially making it difficult to sell your home. You also run a risk of foreclosure if you run into problems making monthly payments. 
• Closing costs: You’ll have to pay various fees to obtain your funding, such as appraisal fees, origination fees, credit report fees, and more. Altogether, these fees can range from 2% to 5%, significantly bumping up your overall financing costs. 
• Qualifications: You’ll need a good credit score (620 or higher), a low debt-to-income ratio (43% or less), and sufficient equity in your home (20% or more) to qualify for the best home equity loans and HELOCs. Otherwise, your costs may increase or you may be denied.
• Tax deductible: You may be able to deduct any interest you pay for either type of debt on your tax return along with your primary mortgage if you used the funds to buy another home or complete home improvements on your current house. 
• No restriction on funds: You can use the loan funds for nearly any purpose, such as consolidating high-interest debt, catching up on home repairs, or renovating your home.

Differences between home equity loans and line of credit

If you’ve decided that borrowing against your home’s value is worth it, the next decision you’ll need to make is what type of debt is a better fit. It helps to know your specific goals when it comes to borrowing money, even if it’s as simple as having an extra option to draw on in case of emergencies. Consider these differences between HELOCs and home equity loans to decide which is a better fit:

• Payout: The biggest difference is how you receive funds. A home equity loan offers all the funds at once, similar to a personal loan. A HELOC, however, allows you to draw against a line of credit over time. 
• Interest rates: Home equity loans offer fixed interest rates. HELOCs, on the other hand, come with variable interest rates that can cause your monthly payment and overall borrowing costs to fluctuate over time. 
• Ongoing fees: As long as you make on-time payments, you won’t typically have to worry about other fees with a home equity loan. HELOCs, on the other hand, may charge additional annual maintenance fees and separate draw fees. 
• Repayment structure: Home equity loans are paid off over the course of five to 30 years with a series of equal payments. In contrast, HELOCs are split up into two parts: an interest-only draw period lasting five to 10 years, and a 10 to 20-year repayment period. 
• Monthly payment amount: Home equity loan payments won’t change over the course of the loan, making it easy to plan in your budget. HELOC payments may constantly change due to the variable rate and the shift in payments from the draw to repayment phases. 

When is a HELOC a good idea?

The biggest difference between a HELOC and a home equity loan is that a HELOC allows you more flexibility to borrow money when you need it. If you’ll be borrowing funds for multiple purchases over several months or years, then a HELOC is a no-brainer when it comes to home equity financing options. Some people prefer to have an open HELOC even if they don’t have specific plans to borrow because a HELOC can offer extra peace of mind if you’re still building up your emergency savings fund. 

‍

There are a few other considerations as well. A HELOC offers easy access to funds, but for some people, it can be a little too easy. It’s a similar dilemma that many people have with credit cards. If money is too easy to access and you haven’t yet developed good financial habits, it may be easier to wind up with a larger amount of debt than you intended. Thus, HELOCs are recommended for people with strong financial management skills. 

‍

In addition, HELOCs have more payment variability. It’s not uncommon for payments to double (or more) over the course of repaying the debt. This can easily happen if you’ve borrowed a significant amount of your credit limit by the time you enter the repayment phase, and even more so if the current interest rate environment has driven your HELOC variable rates higher. If you have good financial management skills, such as keeping your debt-to-income ratio low, these monthly payment fluctuations will be easier to handle. 

When is a home equity loan a good idea?

Home equity loans are generally a better choice if you have one specific purchase you’ll be making, especially if you’ll need to borrow a large loan amount for something like installing solar panels on your home. Taking out a loan only for the specific funds you need — without the added temptation of borrowing more when it may not be entirely necessary — is often a better approach in general, according to financial experts. 

‍

A home equity loan can also be a better choice if you’re looking to save money on financing costs. You may have to pay origination fees and other closing costs, but once the loan is disbursed, you won’t have to worry about annual maintenance fees, draw fees, or other costs as you would with a HELOC. 

‍

Home equity loans are also a better choice for managing your budget. Your monthly payment will stay the same until the loan is entirely paid off, regardless of what the broader economy decides to do. You won’t ever have to worry about finding extra money in your budget to cover the cost of an unexpectedly higher payment. 

‍

If interest rates rise, you’ll be secure in knowing that you’re locked in at a good rate. On the other hand, if interest rates fall, you can always refinance your home equity loan for a lower rate. (Make sure to use a home equity loan refinance calculator first, to make sure you’ll still save money after paying for another round of closing costs).

Alternative equity products

Home equity loans and HELOCs are two of the most popular ways to tap into your home equity, but they’re not your only options. Before you settle on one or the other, consider whether a cash-out refinance loan or a home equity investment might work better for you. 

‍

A cash-out refinance is similar to any other mortgage refinance, except you borrow a larger loan amount than what you owe. In return, you get the excess money back as loan funds that you can use for whatever you need. You can think of a cash-out refinance as rolling your new loan in with your existing mortgage, rather than keeping them as separate debts as with a home equity loan or HELOC. 

‍

You’ll be paying off those funds for a longer period, which can drive up the overall amount of interest you pay. If you’re able to refinance your mortgage for a lower interest rate or a smaller monthly payment, it may be worth it. 

‍

A home equity investment (HEI), on the other hand, allows you to access funds now in exchange for a future portion of your home equity. Because an HEI is an investment, it does not require any monthly payments. You’ll repay the funding in one balloon payment in 10 or 30 years, or sooner if you sell your home or decide to repay early. 

‍

Because your HEI repayment is tied to the appreciation of your home, your buyback costs will vary based on how well your home does. Some HEI providers, such as Point, offer a Homeowner Protection Cap that places limits on the amount you have to repay in the event of major home appreciation. An HEI comes with less stringent qualification requirements than a HELOC or home equity loan. 

Final thoughts

The difference between HELOCs and home equity loans seems fairly straightforward at first, but the more you dig into it, the more factors there are to consider. 

‍

In general, financial experts recommend tapping into your home equity if it’ll raise your home value further, although it may also be useful in other cases such as debt consolidation. Home equity loans can be especially useful for this, but HELOCs can offer added flexibility that can be especially useful for DIY weekend warriors. In either case, it’s wise to also consider your other options for tapping into home equity, including HEIs and cash-out refinance loans.