HELOC vs. Home Equity Loan: How to Choose
As you make your mortgage payments each month, you build equity in your home. And that growth doesn’t have to just sit on the sidelines — you can tap into your home equity when you need extra cash to tackle home improvements, cover education expenses or consolidate high-interest debt.
You have two loan options: a home equity loan or a home equity line of credit (HELOC). A HELOC can give you access to a credit line with a variable interest rate, while a home equity loan gets you a lump sum of cash you’ll pay back at a fixed rate — and both allow you to access up to 85% of your home equity.
We’ll break down the key differences and similarities between the two and help you decide which loan product makes the most sense for your financial goals.
HELOC vs. home equity loan: How they work
A HELOC and a home equity loan both allow you to convert the home equity you’ve built into cash.
What is a HELOC?
A HELOC is a revolving line of credit that works like a credit card — except it’s secured by your home. You can withdraw money as needed up to a maximum limit, pay the balance down to zero and reuse the line for a set time frame called a “draw period.” After the draw period ends, you’ll have pay the remaining balance in full or on a fixed payment schedule.
What is a home equity loan?
Home equity loans are fixed-rate loans that provide cash in a lump sum and have a set repayment period that usually ranges between five and 15 years. Home equity loans are also called “second mortgages,” because they’re second in line to be repaid in a foreclosure sale if you default on your loan.
Similarities and differences: HELOC vs. home equity loan
Both loan options typically allow you to access up to 85% of your home equity, and they’ll both come with closing costs, monthly payments and a lien against your home. The table below summarizes the differences between HELOCs and home equity loans.
| HELOC | Home equity loan | |
|---|---|---|
| Payout type | You access funds as needed using a card or checks | You receive a lump-sum payment all at once |
| Interest rates | You’ll usually have a variable rate | You’ll usually have a fixed rate |
| You’ll typically pay lower rates than for a home equity loan | You’ll typically pay higher rates than for a HELOC | |
| Payment structure | Your monthly payment is only based on the amount you use | Your monthly payment is based on the full loan amount |
| You may be able to make interest-only payments during the draw period | You’ll make equal monthly payments over the entire loan term | |
| Your monthly payment could increase dramatically when the draw period ends | Your monthly payment amount stays the same until the balance is paid off | |
| Fees and extra costs | You may have annual or membership fees, in addition to closing costs | You’ll pay closing costs only once, when you close on the loan |
| You could be charged a fee for paying off the credit line too early | You won’t be charged a fee for prepaying and closing out the loan early |
When is a HELOC a good idea?
If you’ll be making multiple purchases, a HELOC may be the way to go because you can draw on the funds as needed. A HELOC also makes sense if you want to enjoy the lowest monthly payments possible — at least during the draw period.
- Major renovations that will improve your home’s value, such as:
- A kitchen remodel
- Finishing a basement
- Room addition
- Consolidating or paying off debt
- Higher education expenses
- Business startup costs
When is a home equity loan a good idea?
If you’re planning a single big purchase or want the consistency of a fixed-rate loan with stable monthly payments, a home equity loan can serve you better than a HELOC.
- Smaller home improvements spread out over time such as:
- New appliances
- HVAC or another system upgrade
- New flooring
- Unexpected expenses like a medical bill or car repair
- A financial cushion for sudden drops in commission or self-employed income
- Ongoing financial or investment needs like:
- Buying and fixing up an investment property
- Side hustles that require inventory purchases to process orders
Beware of using home equity to pay credit card debt
How much can I borrow with a HELOC vs. home equity loan?
You can use a home equity loan and home equity line of credit calculator to estimate how much cash you can get with a home equity loan or HELOC using standard guidelines. As an example, if your home is worth $250,000, and your current loan balance is $175,000, you could access $37,500 with a home equity loan or HELOC.
And if you want to access more cash than this 85% limit would allow, you can look into lenders who offer high-LTV home equity loans.
Know the risks of borrowing against home equity
HELOC pros and cons
| Pros | Cons |
|---|---|
You can access money over and over without having to close or reopen the line of credit You’ll have the option to make low, interest-only payments You’ll have lower interest rates than personal loans or credit cards can offer Your interest may be tax-deductible if you use the loan for home improvements | You could suddenly see a jump in your monthly payments because the interest rate is adjustable You might have to pay annual membership and close-out fees You might have a balloon payment due after the draw period ends (usually after 10 years) Your lender could lower your credit limit or freeze the HELOC altogether if home values drop Your annual percentage rate (APR) may not reflect the closing costs you pay You could lose your home if you default on the loan |
Pros and cons of home equity loans
| Pros | Cons |
|---|---|
You’ll have a fixed payment for the life of the loan, which can make budgeting simpler and avoids the risk of payment shock You can pay lower interest rates than a personal loan or credit card would offer Your interest may be tax-deductible if you use it for home improvements Your APR will reflect all closing costs | Your interest rate would likely be higher than a rate on a HELOC or first mortgage Your closing costs could be as high as 2% to 6% of the loan amount You could lose your home to foreclosure if you default |
HELOC requirements vs. home equity loan requirements
To qualify for a loan that taps your home equity, you’ll have to meet certain credit score, debt-to-income (DTI) ratio and loan-to-value (LTV) ratio requirements.
Both loan types typically require:
- Minimum credit score: 620
- Maximum DTI ratio: 43%
- Maximum LTV ratio: 85%
Can I get a HELOC or home equity loan with bad credit?
Yes, it’s possible to get a HELOC or home equity loan even if you have bad credit. That said, a low credit score can cause lenders to hike up your interest rate enough that you may want to consider other options. If your score is below 620, you may want to look into a cash-out refinance backed by the Federal Housing Administration (FHA cash-out refinance) or U.S. Department of Veterans Affairs (VA cash-out refinance).
Frequently asked questions
The main drawback of variable-rate loans is their unpredictability. Since these loans have interest rates that are tied to the broader market, you won’t know for sure when you sign up what your future payments will look like. With HELOCs, in particular, there’s the additional danger of “payment shock” when you reach the end of the draw period and have to start making payments on both interest and principal.
A HELOC is riskier for a lender because it’s second in line — after the primary mortgage — to be repaid in the event of a foreclosure. If there isn’t enough money to go around once the primary mortgage debt is paid off, a HELOC lender may be out of luck unless they are willing to sue.
For a borrower, that added risk results in higher interest rates. HELOCs that are kept until the end of the draw period and HELOCs that have balloon payments are associated with higher rates of default.
There’s no way to say for certain, since HELOC rates are variable. However, no matter your loan amount or interest rate, it’s common for HELOC payments to double once the draw period ends. As an example, consider a $50,000 HELOC taken out at a 6% interest rate. If you use anywhere between $500 and $15,000 each year during the draw period, your average monthly payments could be around $175. But, once the repayment period begins, you could be looking at payments of more than $550 per month.