HELOC vs. Home Equity Loan: What's the Difference?

It's more than just how the loan is paid out to borrowers

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Building equity is one of the primary benefits of homeownership. Over time, your property can increase your wealth, but that money is only available when you sell or borrow against your home. When it comes to borrowing and using your home as collateral, have several options, including a home equity line of credit (HELOC) and a home equity loan.

A HELOC allows homeowners to take out a revolving line of credit, while a home equity loan pays out in one lump sum. Learn more about the differences to find out which type is right for you.

What's the Difference Between a HELOC and a Home Equity Loan?

HELOC Home Equity Loan
Variable rate Fixed payments
Repeated borrowing allowed One-time loan
Can be repaid repeatedly Set repayment term

Distribution

A HELOC provides a pool of money that you can draw from as needed. Your lender sets a maximum borrowing limit, and you can use as much or as little as you need, similar to a credit card.

A home equity loan gives you a lump sum. You and your lender agree on an amount, and you receive the entire amount in one transaction.

Spending

HELOCs typically feature a 10-year “draw period” during which you can borrow multiple times. To access the funds, you can often write checks, use a payment card that’s linked to your loan, or transfer funds to your checking account.

Because you receive everything at once, a home equity loan can provide funding for large expenses. If you’re paying multiple expenses or paying over time you can keep any excess amount in your checking account, and spend as needed.

Payments

With a HELOC, you may have the option to make small, interest-only payments on your debt during the draw period. Eventually, you enter a repayment period where your payments go toward both principal and interest. Once you start the repayment period, you can no longer borrow.

Most home equity loans are repaid with fixed monthly payments. Your payment amount and interest rate typically don’t change over time. Instead, your bank calculates a repayment schedule that includes both your interest costs and loan repayment in every monthly payment.

Interest

HELOCs have variable interest rates and should start with lower interest rates than home equity loans. But if rates rise, your borrowing costs can increase.

You can minimize interest costs by keeping a small balance (or zero balance) on your HELOC. Only borrow when you need money.

With a home equity loan, on the other hand, interest is charged on the entire amount of your loan starting in the first month. However, the interest rate is typically fixed. This helps to provide predictable, level monthly payments.

Your interest costs are highest at the beginning of your loan. To see how the math works, learn about loan amortization. You can minimize interest costs by paying off your loan early, assuming there are no prepayment penalties.

How HELOCs and Home Equity Loans Are Similar

In some ways, home equity loans and HELOCs are similar:

  • Second mortgages: Both loans are often second mortgages that you can use in addition to an existing home-purchase loan.
  • Home equity: You borrow against the equity in your home, which is the value of your home that you actually own after accounting for any mortgage loan balance.
  • Secured by your home: Both loans use your home as collateral. If you stop making payments, your lender can potentially force you out of your home through foreclosure. Putting your home on the line is risky, especially if you use the loan for expenses that don’t improve the home’s value.

Lenders limit how much you can borrow with both home equity loans and HELOCs. In most cases, you can borrow up to 85% of your home’s value with either a home equity loan or a HELOC—including any existing debt on the property. Some lenders allow you to borrow more, but interest rates and costs rise as you borrow more. For the best terms, keep your loan-to-value (LTV) ratio below 80%.

Example: Your home is worth $300,000, and you owe $100,000 on your original purchase mortgage. How much is available for a second mortgage (assuming you have sufficient income and credit scores to qualify)?

  1. Home value: $300,000
  2. Existing mortgage debt: $100,000
  3. Maximum debt amount, assuming 80% LTV: $240,000 (multiply 0.80 by $300,000)
  4. Amount available to borrow: $140,000 (subtract the existing debt of $100,000 from the 80% maximum of $240,000)

Which Is Right for You?

Because each type of loan works differently, you'll need to choose the type of loan that best fits your needs.

A HELOC could be the right choice for you if you want a flexible borrowing schedule. You can borrow and repay numerous times over a 10-year period. Getting money is as easy as writing a check or swiping a payment card—you don’t need to apply every time you need more funding. Pay off the balance when you’re able to do so, and borrow again if needed.

A home equity loan, on the other hand, could be better if you want to know exactly how much you need and you want predictability when it comes to repayment. Your monthly payments won’t rise if rates increase, and you don’t need to worry about your lender freezing your credit line or cutting your credit limit.

Also, if you're consolidating your debt, it can be risky if you choose to use your home equity. But a home equity loan can convert high-interest-rate debts to a low, fixed rate. The resulting savings may be significant—but make sure you don’t go back into debt. If you're susceptible to that, the one-chance home equity loan is a safer option than a HELOC.

The Bottom Line

HELOCs and home equity loans are both options when it comes to using your home for loan collateral.

A HELOC may be best for those who are looking for borrowing flexibility and a revolving line of credit. A home equity loan might be the right choice for those who need a lump-sum loan with regular monthly payments.

In the end, the right choice for you depends on your individual circumstances and borrowing preferences.