HELOC vs. Home Equity Loan: How to Choose
Homeowners can use their home equity to finance major expenses, like home improvements, college tuition or debt consolidation. Two common options are a home equity line of credit (HELOC) or a home equity loan. Understanding the differences, along with the benefits and risks of each, can help you pick the right product for your situation.
- A HELOC is a credit line you can draw from over a set time period, while a home equity loan provides a lump sum all at once.
- Your HELOC or home equity loan payment amount will depend on how much you borrow, the repayment period and the interest rate.
- Both HELOCs and home equity loans are secured by your home, which means you could lose your home to foreclosure if you miss payments.
HELOC vs. home equity loan: At a glance
| HELOC | Home equity loan | |
|---|---|---|
| What it’s best for | Ongoing expenses, like multiple home repairs or business startup expenses | Best for large, one-time expenses, like debt consolidation or a single home improvement project |
| Interest rate | Usually variable | Usually fixed |
| Payout type | Access funds from your credit line as needed | One lump sum |
| Repayment structure | Payments vary and are based on your outstanding balance. You may also have an interest-only payment option. | Payments are fixed and include both principal and interest charges. |
| Closing costs | 2% to 5% of the credit limit | 2% to 5% of the loan amount |
| Other fees | There may be annual fees, inactivity fees or early termination charges. | Few to none |
What is a HELOC?
A HELOC is a revolving credit line you take out against your home’s equity. It works similarly to a credit card in that you have a set limit that you can borrow against, repay and then use again. Unlike credit cards, though, HELOCs are secured by your home, which means you could lose your home if you default on the loan.
You can generally use a HELOC repeatedly over a set time known as the “draw period,” which typically lasts 10 years. During this time, you may have the option to make low, interest-only payments.
When the draw period ends, the “repayment period” begins — it’s often 10 to 20 years. If you were making interest-only payments, you’re to begin making full principal-and-interest payments at this time. Since HELOC rates are usually variable (meaning they can go up or down) your monthly payments can get more expensive over time.
Pros and cons of HELOCs
Pros
- You can access money repeatedly over the draw period.
- You only pay interest on the money you use.
- Your interest rate will likely be lower than a home equity loan, cash-out refinance, personal loan or credit card.
Cons
- Your monthly payments could increase due to the variable interest rate.
- Your lender could lower your spending limit or freeze the HELOC altogether if your financial situation changes.
- You could lose your home to foreclosure if you default on the payments.
What is a home equity loan?
A home equity loan provides a lump sum of money upfront that you can use for major purchases, like college tuition or a down payment on a vacation home. Like HELOCs, home equity loans use your home as collateral, so the lender could take possession of your home if you default on the payments.
Home equity loan rates and payments are generally fixed from the start of the loan, so payments are more stable and predictable than HELOCs. Loan terms typically range from five to 10 years, but some lenders may offer terms of up to 30 years.
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Pros and cons of home equity loans
Pros
- You’ll have fixed monthly payments for the entire loan term.
- You’ll likely get a lower rate than you would with a personal loan or credit card.
- You won’t have as many ongoing fees as you might with a HELOC.
Cons
- You’ll risk foreclosure if you default on the loan payments.
- You won’t be able to access more money without applying for another loan.
- You could pay up to 5% of the total loan amount in closing costs.
HELOC rates tend to be slightly lower than home equity loan rates. However, HELOC interest rates are variable while home equity loan rates are fixed — this makes home equity loan payments more predictable. Since a cash-out refinance is considered a “first mortgage,” lenders view them as less risky and typically offer lower rates than home equity loans and HELOCs.
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HELOC and home equity loan requirements
To qualify for either a HELOC or home equity loan, you’ll typically need to meet the following requirements:
-
Home equity: 15% minimum
Before qualifying for a HELOC or home equity loan, you’ll need to have built up a certain amount of equity in your home — typically 15%, though this varies by lender. You can calculate your home equity by subtracting your mortgage balance from your home’s value. If you want to access more cash, look into high-LTV home equity loans. -
Credit score: 620 minimum
Home equity lenders will look at your credit history and credit score to help them decide whether they can approve you for a loan. Many lenders will want to see at least a 620 credit score, but the best rates will go to borrowers with higher scores. -
Debt-to-income (DTI) ratio: 43% maximum
Your DTI ratio compares your monthly debts to your monthly income. Its purpose is to help lenders determine if you can afford the monthly payments on the loan you want to take out. Many lenders require a 43% DTI ratio or lower, which means your monthly debt payments can’t be more than 43% of your monthly income.
Learn more about home equity loan requirements.
Should I get a HELOC or home equity loan?
To choose between a HELOC and a home equity loan, consider these questions:
- Do I want the money all at once or in the form of a credit line I can use over time?
- Which do I value more: predictable monthly payments or ongoing access to funds?
- Am I prepared to pay closing costs and ongoing fees?
A home equity loan could be a good fit if you want the money all at once and value predictable payments and fewer ongoing fees. On the other hand, a HELOC is a better option if you’d prefer to draw from a credit line on an ongoing basis, even if payments are a bit less stable due to the variable interest rate.
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