HELOC vs. Home Equity Loan: Which is Better?

Read Time: 9 minutes

A home equity line of credit (HELOC) and home equity loan can offer flexible funding for almost any need, whether you’re looking to make home improvements, consolidate debt, or cover major expenses like medical bills. 

While HELOCs and home equity loans both offer a wide range of uses, their differences influence the scenarios they can best be utilized. 

Today, we’ll explore the key differences between a home equity loan and a home equity line of credit, along with the pros and cons, and ideal uses to help you decide which option is best for you.

HELOC vs. Home Equity Loan Basics

HELOCs and home equity loans often get confused because they have similar names and involve borrowing against home equity. However, HELOCs and home equity loans are actually more different than they are alike. 

A home equity loan is more like a traditional loan. You borrow a lump sum and immediately begin paying it back in installments. Home equity loans have fixed interest rates and consistent monthly payments against the interest and principal. 

On the other hand, a HELOC is like a credit card that uses your house as collateral. You can borrow money whenever you need it (up to a predetermined limit), and you only have to make payments on the interest during the draw period (usually 5-10 years). 

Home Equity Line of Credit (HELOC)Home Equity Loan
Interest rates are typically variableInterest rates are typically fixed
Payments only on the interest during the draw periodPayments on the principal and interest throughout loan term
Revolving credit lineOne lump sum payment
Wide range of usesWide range of uses
Uses your home as collateralUses your home as collateral

Overall, the key similarity between a home equity loan and a line of credit is that you use part of your home equity as collateral for the loan. The key difference is in how you borrow the money and how you pay it back. 

Qualifying for a Home Equity Loan or HELOC

The primary qualification for a home equity loan or HELOC is having home equity. 

Credit requirements are stricter than on a mortgage to buy or refinance a home. Many lenders require a FICO score of 720 or higher. Some lenders will accept scores of 660 or below but expect to pay higher rates and face tighter loan-to-value (LTV) limits.

As for income, your monthly debt payments (including your primary mortgage and the added costs of a home equity loan or HELOC) should total no more than 45% of your pretax income.

Most home equity loans and HELOCs have no restrictions on how you use the money. You don’t need to demonstrate a need for the money or justify it to the lender; you just have to qualify for the loan. Some special loan programs for things like medical expenses or home improvements may be an exception, though.

HELOC vs. Home Equity Loan Rates

Home equity loans and HELOCs generally have lower interest rates than other unsecured loans but higher rates than purchase or refinance loans. 

Home equity loans come with fixed interest rates, which means your interest rate and monthly payments remain constant over the life of the loan. 

Many HELOCs start out as interest-only adjustable-rate mortgages. During the draw period, the interest rates are tied to a benchmark, such as the prime rate. After the draw period ends, you enter a repayment phase (usually 10-20 years) to repay the borrowed amount. While some HELOCs have rate caps, your rate will likely fluctuate over the life of the line of credit, affecting your monthly payments. 

Though not as common, it is also possible to get a fixed-rate HELOC or HELOC that fluctuates between variable and fixed rates. 

HELOC vs. Home Equity Loan Pros and Cons

Let’s review some of the pros and cons of HELOCs vs. Home Equity Loans:  

Home Equity Line of Credit (HELOC)Flexibility: You can borrow as much as you need (up to your credit limit).
Lower monthly payments: During the draw period, you only have to make payments on the interest. 
Revolving access to funds: Like a credit card, once you repay borrowed money, your available credit increases, offering continuous access to funds during the draw period. 
Interest rate volatility: HELOCs fluctuate over time, which can increase your payments and total loan cost.
Risk of overborrowing: The flexibility to borrow can lead to spending more than planned, increasing your debt.
Payment complexity: With variable interest rates and flexible withdrawal options, predicting monthly payments and managing a consistent budget can be harder.
Home Equity LoanFixed interest rates: The interest rate is fixed, so your monthly payments remain consistent throughout the life of the loan.
Lump-sum payment: You receive the entire loan amount upfront, which is great for large, one-time expenses.
Less flexibility: Unlike a HELOC, you can only borrow more money if you apply for a new loan.
Upfront lump sum: Receiving a lump sum means paying interest on the entire loan amount from the start, regardless of whether you use all the funds immediately.

HELOCs and home equity loans share several advantages and drawbacks. Because they are secured by your home, both typically offer interest rates lower than those of credit cards or personal loans, often half or less. However, this security means your home could be at risk of foreclosure if you’re unable to repay. 

As second mortgages, HELOCs and home equity loans rank below the primary mortgage on your home. This hierarchy means the primary mortgage is settled first in the event of a default, making HELOCs and home equity loans slightly riskier than primary mortgages. 

HELOCs and home equity loans also both offer potential tax breaks. According to IRS guidelines, interest paid on both may be tax-deductible if the loan is used to buy, build, or substantially improve the taxpayer’s home that secures the loan.

HELOC vs. Home Equity Loan: Which is Better?

When deciding between a HELOC and a home equity loan, which one is better depends on your finances and what you are trying to fund. 

Home equity loans have a consistent repayment structure, starting immediately after the loan is disbursed. The interest rate stays the same, so your payments are always the same amount, making it easier to budget. The repayment schedule for a home equity loan is simple and easy to follow. 

HELOCs are more complicated, but they’re also more flexible. They provide a credit line you can draw from up to a set limit during a 5 to 10-year period. During the draw period, you are only required to make payments on the interest. However, you can make extra payments towards the principal if you want. This will reduce future payments and replenish your available credit, which helps manage cash flow by allowing you to borrow and repay as needed.

For Renovations

Deciding between using a HELOC or a home equity loan for a home renovation can be tricky.

Renovations can be uncertain in terms of timing and budgeting. You can enter a project wanting to spend a certain amount, only to find out you’ll have to dish out even more to get it done.

A HELOC might suit you better if you have multiple projects to fund and you don’t mind unpredictable payments.

A home equity loan is likely the better option if you have a strict budget. If you need flexibility but want consistent payments, a home equity loan could still be a good fit. Just borrow more than the estimated project costs, so you have a cushion. If you underestimate your project costs, you won’t be able to take out more money without applying for another loan. 

For Debt Consolidation

A home equity loan is likely the best option for debt consolidation. 

HELOCs are complex, with variable rates and a complicated payoff structure. Furthermore, the very flexibility of a HELOC requires discipline to avoid further debt accumulation. If you are certain about the total amount needed to consolidate your debts, the straightforward repayment structure of a home equity loan is most beneficial. 

For a Down Payment on a House 

If you’re trying to raise funds for a down payment on a new house, a home equity loan is generally better than a HELOC. A home equity loan provides a lump sum of cash with a fixed interest rate, making it easier to plan for the exact amount needed upfront and manage repayment over time. 

Home Equity Loan vs. HELOC Frequently Asked Questions

How Much Can I Borrow?

Our home equity loan calculator makes figuring out how much you can borrow with a HELOC or home equity loan easy. 

To find out how much you can borrow for your home equity loan, divide your mortgage’s outstanding balance by your home’s current value. This gives you your loan-to-value (LTV) ratio. Home equity lenders will generally allow you to borrow against 75-90% of the assessed value of your home for all loans combined, primary mortgage, and a home equity loan/line of credit. 

For example, say you have a $400,000 home, and the lender allows 80% LTV. This means you can have up to $320,000 total in debt (80% of $400,000 is $320,000). This LTV amount includes your primary mortgage and home equity loan/HELOC amount. 

So, if you owe $250,000 on your primary mortgage, you would have $70,000 available ($320,000 – $250,000) for a home equity loan or line of credit.

You should also keep in mind that HELOC and home equity loan lenders often have minimum borrowing requirements that typically range from $5,000 to $10,000. 

Why is Home Value Important for a HELOC/Home Equity Loan? 

Home value is crucial for a home equity loan because the loan amount is based on the equity you have in your home, which is the difference between the home’s current market value and any outstanding mortgage balance you owe. 

How Do I Figure Out My Home’s Value? 

Lenders typically have home valuation tools that you can use when applying for a HELOC or home equity loan. Here are a few strategies you can use to figure out your home value on your own: 

  1. Hire a professional appraiser: For the most accurate valuation, hire a professional appraiser. They will consider your home’s condition, location, size, and recent sales of comparable properties in your area.
  2. Use online valuation tools: There are many free automated valuation models (AVMs) online that estimate your home’s value based on public records and market data.
  1. Get a comparative market analysis (CMA): Real estate agents can provide a CMA, which analyzes the prices of similar homes that have recently sold or are currently for sale in your neighborhood.
  2. Review recent sales of similar homes: Look at the sale prices of homes similar to yours in your area. Focus on recent sales (within the last 3-6 months) for the most current market conditions.

Are Home Equity Loans Amortized?

Yes, home equity loans are fully amortized. Always. Every repayment will involve a portion of the principal and the interest. HELOC loans are not fully amortized. They only require you to make interest-only payments during the draw period.

How Do I Calculate a HELOC Payoff?

Use our HELOC payoff calculator to figure out your amortization schedule. 

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