Home equity loan vs. HELOC: What’s the difference?
Home equity loan Both of these products let you borrow against your home equity, giving you cold, hard cash in return. You can then use that money to pay for renovations, cover unexpected bills or expenses, consolidate debt, or manage any other financial need you might have.
Just choose wisely: While HELOCs and home equity loans have some similarities, the two aren’t one and the same. Here’s how these products differ — and how to choose the right one for your needs.
What’s a home equity loan?
Home equity loans let you turn your home equity into a one-time lump sum payment. You then repay the loan via fixed monthly payments over an extended period of time — usually 10 to 30 years.
Many homeowners use home equity loans to cover the costs of repairs, renovations, or other expenses around the house. Others use them for bills or paying off debts.
Pros
One big benefit of home equity loans is that they’re typically more affordable than other financing options.
“A home equity loan often comes with a lower interest rate than other loans since your home is secured as collateral,” says Josip Rupena, founder and CEO of milo, a financial technology firm and mortgage provider. “This type of financing also typically offers more money all at once than personal loans or credit cards, which may be useful if you only need to make a one-time large purchase.”
Home equity loans also typically have fixed rates, which means your interest rate and payments are consistent for the entire loan term. This can make for easier budgeting and prevent any payment hiccups.
Finally, you can typically access fairly large sums with home equity loans. Most lenders allow you to borrow up to 85% to 90% of your home’s value minus your existing mortgage balance. So if your home is worth $400,000 and your mortgage balance is $100,000, you could potentially borrow up to $260,000 ($400,000 x .90 – $100,000).
Cons
The biggest downside to home equity loans is that they put your home at risk.
“Your home is the collateral for the loan,” Rupena says. “Using your residence to secure the loan is inherently risky. Sudden life changes, such as the loss of a job or a medical emergency, could jeopardize your ability to repay what you’ve borrowed. If you default on a payment, the lender may be able to take your home.”
Home equity loans also come with a second monthly mortgage payment (in addition to your main mortgage), and you’ll get just a single upfront sum. (Whereas with HELOCs, you can withdraw funds over time as needed. More on that below.)
What’s a home equity line of credit?
A home equity line of credit is another option for borrowing against your home equity. Unlike home equity loans, these work more like credit cards, allowing you to withdraw money, pay some back, and withdraw more when you need it.
Typically, HELOCs come with a 10-year draw period, which is when you can withdraw money from the credit line. During this time, you’ll usually pay only interest on the funds you pull out.
After that, most HELOCs have a 20-year repayment period. This is when you’ll start paying the lender back both principal and interest. In rare instances, you may have to repay the HELOC balance in full at this point (it’s rare, but it’s called a balloon payment).
Pros
The major upside of HELOCs is that you get access to cash for a long period of time. You can withdraw $10,000 for repairs now, $20,000 later, pay some back, and borrow more a few years down the line.
Additionally, you’ll only pay interest on what you take out — not the full credit line you’re granted.
“You only pay on what you use,” says Scott Lieberman, managing editor of Touchdown Money. “Even if you take out a HELOC for $50,000 but only use $20,000, you only have to pay on the $20,000.”
A final advantage is that HELOCs often have very low interest rates upfront. These typically only last a few years, though, so make sure you read the fine print before taking one out.
Cons
Like home equity loans, HELOCs also put your home at risk. If you fail to make your payments — which can be challenging with any type of second mortgage — your lender could foreclose on your house.
On top of this, HELOCs usually come with variable rates, meaning your interest rate and monthly payment can rise over time. This could make it hard to stay on top of payments and put your home at an even higher risk of foreclosure.
How HELOCs and home equity loans differ
HELOCs and home equity loans both let you borrow against your home equity, but they have some pretty significant differences.
Home equity loans come with a lump-sum payment, while HELOCs let you withdraw funds over many years. Home equity loans have consistent interest rates and payments. HELOCs, on the other hand, have rates and payments that can fluctuate.
Here’s a look at the key differences between these products:
Is a home equity loan or HELOC better?
Choosing between a home equity loan and a HELOC can be challenging. To start, think about what you plan to use the funds for — and how long you’ll need them.
If you’re renovating your home, for example, and will need an unknown amount of cash over an extended period of time, a HELOC may be a better fit. These can also be smart options if you want a financial safety net, just in case.
A home equity loan can be wise if you have a good handle on how much you need (since borrowing more than that will mean paying unnecessary interest).
“When you have more certainty about the amount of money you need and the duration, such as consolidating high-interest debt, a fixed-rate home equity loan may be a better option,” says Zeenat Sidi, president of digital products and services at loanDepot.
You should also think about your budget. If you want a lower interest rate but can manage a possibly higher rate and payment down the road, a HELOC can work. If a consistent and reliable payment is most important, choose a home equity loan.
“With its fixed interest rate, you’ll know just how much your payments will be for the life of the loan, which allows you to plan accordingly,” Sidi says.
Home equity rate trends
You’ve probably heard that the Federal Reserve has been increasing interest rates this year, but what does that mean for home equity loan and HELOC rates? For HELOCs, it means immediately higher rates. That’s because HELOCs and other short-term borrowing products (like credit cards, for example) are generally directly tied to the Fed’s rate. When that rate rises, so do HELOC rates — and their payments.
Bankrate data shows that HELOC rates are currently averaging between 5.51% and 7.50%. A year ago, before the Fed began increasing its rate, HELOC rates ranged from 4.7% to 4.28%.
Home equity loan rates are only loosely tied to the Fed’s moves, but they typically trend in the same direction as traditional mortgage rates. According to Bankrate, rates on home equity loans ranged between 5.09% and 13.99% in November 2022. Overall, that’s up from the end of 2021, when rates hovered around 5.96%.
“As federal rates increase, this causes the banks to raise rates to consumers, therefore raising mortgage and home equity rates,” Lieberman says. “Across the board, all interest rates are rising.”
