One of the great things about homeownership is the potential to build wealth through equity over time. If you’ve been paying your mortgage for a few years, you may have more equity to work with than you think.
Home equity lines of credit (HELOCs) and home equity loans are two lending tools that enable you to put your home’s value to work without selling or refinancing. Even though both products are considered second mortgages, they work differently. Here are some key differences between home equity loans and HELOCs.
Key Takeaways:
- A home equity loan delivers a lump sum and is repaid at a fixed interest rate with predictable monthly payments – ideal for one-time, defined expenses.
- A HELOC typically comes with a variable rate and works like a credit card. You borrow what you need, when you need it – up to a set limit. You pay interest only on the amount used.
- Both home equity products are second mortgages. If you default, your primary mortgage lender gets paid first, leaving home equity lenders in line next.
What Are HELOCs And Home Equity Loans?
Home Equity Line Of Credit (HELOC)
A HELOC gives you access to a revolving line of credit, tied to your home equity, that you can draw from as needed. You pay interest only on the amount you use. It works similarly to a credit card, but it’s secured by your home.
A HELOC has two phases: draw and repayment. During the initial draw period – typically 10 years – you can borrow, repay and borrow again from your line of credit, paying interest only on what you use. At the end of the draw period, the line of credit closes and the repayment period – 10 – 20 years – on the outstanding amount starts. This is when you’ll pay down your remaining balance.
Most HELOCs carry variable interest rates, so your monthly payment can fluctuate as those rates change. If you don’t love rate swings, some lenders offer fixed-rate HELOCs, but you’ll have to shop around to find that option.
Home Equity Loan
A home equity loan lets you borrow a fixed amount against your equity. You get the full amount up front, and repay it in equal monthly installments with a fixed interest rate for the life of the loan. It’s a second mortgage with the same structure and predictability as your primary home loan.
Terms on home equity loans run 5 – 30 years, and rates are typically higher than those for a first mortgage, but considerably lower than those of credit cards or personal loans. Like HELOCs, a home equity loan is secured by your home, so if you default, you run the risk of foreclosure.
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HELOCs Vs. Home Equity Loans: Side-By-Side Comparison
| Feature | HELOC | Home Equity Loan |
|---|---|---|
| Accessing loan funds | Credit line you tap as needed (up to its limit) during draw period | Lump sum at closing |
| Interest rate | Typically variable (though some lenders offer fixed-rate HELOCs) | Fixed |
| Draw period | Typically 10 years | None; one-time draw |
| Repayment period | Typically 10 – 20 years after draw period ends | 5 – 30 years |
| Closing costs | 2% – 5% of loan amount | 2% – 5% of loan amount |
| Annual fees | $50 – $250 year | None |
| Rate risk | Rates can increase during draw or repayment periods | None; rate is fixed at closing |
| Best for | Ongoing or unpredictable costs (multiple home projects, college tuition over multiple semesters, ongoing medical bills) | Single, defined expense (major home renovation, consolidating high-interest debt, buying an investment property) |
What’s Your Goal?
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How Much Home Equity Can You Borrow Against?
For both options, this depends on how much equity you have. Most lenders let you borrow up to 80% – 90% of your home’s appraised value, minus your mortgage balance. This is your combined loan-to-value ratio, or CLTV.
Here’s an example:
- Home value: $400,000
- Mortgage balance: $200,000
- Maximum borrowing amount (at 80% CLTV): $320,000
- Subtract mortgage balance: $320,000 – $200,000 = $120,000: Total tappable equity for a HELOC or home equity loan
How To Qualify For A HELOC Or Home Equity Loan
Home equity lenders approve borrowers for both products using similar guidelines. Here’s how to qualify for a home equity loan or HELOC:
- Credit score: Most lenders prefer a minimum credit score of 620 – 680, but scores of 740 or higher earn you the most competitive rates.
- Debt-to-income ratio: The maximum DTI for a HELOC or home equity loan shouldn’t exceed 43%, though some lenders may stretch to 50% with compensating factors, such as a high income or ample cash reserves.
- Equity and LTV: You typically need at least 10% – 20% equity in your home. Most lenders cap borrowing at 80% – 90% of your home’s appraised value (minus your mortgage balance).
- Income: You’ll need to provide two years of W-2s and federal tax returns to show proof of income. Self-employed borrowers may need to provide profit-and-loss and bank statements, too.
- Appraisal: Lenders will order a home appraisal to confirm your home’s current market value.
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What Does Each Loan Cost?
In addition to HELOC and home equity loan interest rates, which are generally slightly higher than primary-mortgage rates, you’ll have closing costs and fee structures to consider when deciding between a HELOC and a home equity loan.
HELOC Costs
- Initial closing costs are usually 2% – 5% of the loan amount, and many lenders advertise no-closing-cost HELOCs in exchange for higher interest rates.
- Annual fees of $50 – $250 are common even if you never draw from the line.
- Some lenders charge a transaction fee every time you tap funds.
- Variable rates mean your total cost over time is harder to budget for. A HELOC that looks affordable today can become harder to manage quickly if rates rise.
Home Equity Loan Costs
- Here, too, closing costs run 2% – 5% of the loan amount. On a $100,000 home equity loan, that’s $2,000 – $5,000 up front.
- There’s no annual fee in most cases, since all the funds are issued at closing.
- The interest rate is fixed, so your total borrowing cost is a known variable.
- Some lenders roll closing fees into the loan balance, so there’s no cash out of pocket. However, you’ll pay interest on that amount over time.
Second-Mortgage Tax Benefit: Deductible Interest
Under current IRS rules, you can deduct interest on home equity loans and HELOCs if you use the funds to “buy, build or substantially improve” the home securing the loan. But if you use it to pay off other debt, buy another home or fund a vacation, you lose access to this tax perk. Consult with a tax professional for additional guidance, as your circumstances may vary.
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Pros And Cons Of HELOCs Vs. Home Equity Loans
Both options have their benefits, but there are also notable differences between HELOCs and home equity loans that might sway your final decision.
HELOC Pros And Cons
| Pros | Cons |
|---|---|
| Borrow what you need, when you need it | Variable rates might push payments higher in the future |
| Pay interest only on what you use (not the full credit line) | Interest-only payments during the draw period mean slower progress on paying down the principal |
| Revolving access lets you repay and borrow again during the draw period | Annual fees apply whether or not you use the credit line |
| Lower initial rates in most conditions; some lenders may waive closing costs | Potential additional fees to watch out for, including transaction fees, early cancellation fees and inactivity fees |
| Useful as a financial safety net even if you never fully draw the line down | The lender can freeze or reduce your line if your home value drops or your finances change |
Home Equity Loan Pros And Cons
| Pros | Cons |
|---|---|
| The fixed rate offers stable, predictable monthly payments | You pay interest on the full amount from the start, even if you don’t use it all right away |
| The lump sum is useful when you know exactly how much you need | Less flexibility: You can’t borrow more if you need additional money |
| More straightforward terms – one closing, one loan and one payoff date | Total costs tend to be higher up front than with a HELOC, which charges interest only on the amount you’re using at any given time (not on the full credit line) |
| No payment shock, which lets you budget more easily for future expenses |
When To Choose A HELOC Vs. Home Equity Loan
Deciding on one product or the other starts with defining your needs. Here are some considerations to help you settle which second mortgage makes most sense for you.
Choose A Home Equity Loan When…
- You have a single, well-defined financial need with a known price tag: a kitchen remodel, a basement completion or debt consolidation with a specific payoff amount.
- You want predictable payments and a fixed interest rate without future price-tag shocks.
- You’re consolidating high-interest debt and want a clear, fixed payment schedule that tangibly improves your financial health.
- You’re risk-averse and prefer to lock in a rate and payment rather than ride an unpredictable market.
Choose A HELOC When…
- Your financial goal is ongoing or its costs are unpredictable. Examples include a multiphase home-improvement project, college tuition to be paid over several semesters or ongoing medical expenses.
- You want a financial safety net that’s available if something comes up, without having to pay interest if you don’t use it.
- You’re comfortable with some rate unpredictability in exchange for flexibility.
- Your project will be done in phases, and you don’t want to borrow more than you need up front.
FAQ: HELOC Vs. Home Equity Loan
The Bottom Line: Your Choice Comes Down To Your Needs
Both a HELOC and a home equity loan let you tap your home’s value – typically at rates well below those of many other financial products. The decision boils down to how you’ll use the money and when you need it.
With both products, however, your home is on the line. Borrow only what you need, and have a repayment plan before committing to a second mortgage. Whether you go with a HELOC or a home equity loan, the equity you’ve built can help you reach other financial milestones – and improve your overall financial picture. Explore your home equity lending options today.
Deborah Kearns
Deborah Kearns is an award-winning independent journalist with more than 15 years of experience covering real estate, mortgages and personal finance. Her work has appeared in the Wall Street Journal, Kiplinger, U.S. News & World Report, Quartz, CNN, Forbes, Fortune, Newsweek, The Associated Press and dozens of other outlets. She previously led content and communications at a Top 15 national mortgage company and held writing and editing roles at Bankrate, NerdWallet, LendingTree and RE/MAX. She holds a bachelor's degree in journalism from the University of Florida and a master's degree in public relations from Ball State University.
