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HELOC vs. Home Equity Loan: How to Choose

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Content was accurate at the time of publication.

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.

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.

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.

HELOCHome equity loan
Payout typeYou access funds as needed using a card or checksYou receive a lump-sum payment all at once
Interest ratesYou’ll usually have a variable rateYou’ll usually have a fixed rate
You’ll typically pay lower rates than for a home equity loanYou’ll typically pay higher rates than for a HELOC
Payment structureYour monthly payment is only based on the amount you useYour monthly payment is based on the full loan amount
You may be able to make interest-only payments during the draw periodYou’ll make equal monthly payments over the entire loan term
Your monthly payment could increase dramatically when the draw period endsYour monthly payment amount stays the same until the balance is paid off
Fees and extra costsYou may have annual or membership fees, in addition to closing costsYou’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 earlyYou 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.

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.

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Beware of using home equity to pay credit card debt


If you’re tapping equity to pay off high-interest credit card debt, you’re solving a short-term problem by going deeper into debt for a longer period — and you’re also putting your home at greater risk of foreclosure. Before using home equity to pay down debt or for major expenses, create a plan for how you’ll repay a home equity loan. More importantly, address the spending habits that caused your debt so you can avoid repeating the cycle.

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.

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Know the risks of borrowing against home equity


No matter which loan type you choose, the most important thing to know when borrowing against your home equity is that you could lose your house to foreclosure if you can’t make your loan payments. But when used responsibly, home equity loans and HELOCs can be a great way to access extra cash.

ProsCons

  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

ProsCons

  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

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) or U.S. Department of Veterans Affairs (VA).

 

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.

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