HELOC Vs. Home Equity Loan: Which One Should You Choose?

9 Min Read
Published Oct. 26, 2023
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Written By Jamie Johnson

If you need to finance a major purchase, there are many options to choose from. Two of the best options that may be available for homeowners are home equity loans and home equity lines of credit (HELOCs).

Both options let you access the equity in your home, and you can use these funds to pay down debt, finance home improvements, or make a major purchase. But a HELOC is given as a line of credit while a home equity loan is paid out in one lump sum.

There are other differences between a HELOC vs. a home equity loan that may help you determine which one is better for your goals.

Home Equity Loan Vs. Line Of Credit: What’s The Difference?

HELOCs and home equity loans both allow you to borrow from the equity you’ve built in your home. And both are considered second mortgages, so you’ll have two mortgage payments each month.

However, the main differences between the two are the interest rates, how you receive the funds, and the repayment terms. For example, a home equity loan is an installment loan while a HELOC is a revolving line of credit.

Home equity loans come with fixed interest rates, while a HELOC has variable interest rates. And you’ll begin repaying a home equity loan as soon as you receive the funds, but with a HELOC, you’ll only repay the amount you actually spend.

How Does A Home Equity Loan Work?

When you take out a home equity loan, your home is used as collateral to secure the loan. This type of financing is also referred to as a second mortgage. You’ll receive the funds once as a lump sum payment, then you’ll begin repaying the loan over a fixed payment schedule.

The amount you can borrow will depend on how much equity you’ve built in your home, and you can usually borrow up to 80% of the home’s appraised value. Home equity loans typically come with a fixed interest rate.

A home equity loan is best for borrowers who know how much money they need to borrow from the start. And if you receive a fixed interest rate, your monthly payments will stay the same over the life of the loan.

How Does A HELOC Work?

A HELOC also uses your home as collateral, but instead of receiving a lump sum payment, you’ll get access to an ongoing line of credit. HELOCs tend to come with variable interest rates.

A HELOC comes with a draw period and a repayment period. During the draw period, you can borrow as much money as you need up to the approved credit limit, and you’re only responsible for repaying the interest.

However, you can repay the credit limit so you can use the repaid funds for another project. If you take out a 20-year HELOC, the draw period will likely last for 10 years. Once the draw period is over, the repayment period begins. At this point, you’ll repay the principal and interest for the remainder of the loan term.

A HELOC may be a good choice for anyone who has a specific project in mind but doesn’t know exactly how much money they’ll need to fund it. The line of credit gives you the flexibility to only borrow and repay what you need.

See What You Qualify For

Differences Between Home Equity Loan And HELOC Requirements

Different lenders have varying requirements for financing, so it’s a good idea to compare your options among several different lenders. Understanding the different credit requirements will help you determine which loan may be right for you. The following chart outlines the differences and similarities between a home equity loan vs. a HELOC:

Financing Type

Credit Score

Debt-To-Income Ratio

Loan Term

Loan Amount

Interest Rates

Home equity loan

Minimum of 680

45% or less

10-20 years

Up to 80% of the appraised value

Fixed

HELOC

Minimum of 620

43% or less

5-30 years

Up to 85% of the appraised value

Variable

Credit Score

To qualify for a home equity loan or HELOC, you’ll need a minimum credit score of 620-680 depending on which loan you get. However, if you want to qualify for the best rates and terms, you’ll want to have good to excellent credit.

Lenders use your credit score to determine how good you are at handling debt. If you barely meet the minimum credit requirements, your lender will either deny you the loan or give you higher interest rates to compensate. 

Debt-To-Income Ratio

In addition to good credit, you’ll also need a maximum debt-to-income (DTI) ratio of 43%. Your DTI measures what percentage of your gross monthly income is going toward debt payments. A DTI above 43% indicates that you may be over-extended financially and not a good candidate for a second mortgage. 

Loan Term

The loan terms for a HELOC start at 5 years and can be extended for as long as 30 years. The main difference between a HELOC and a home equity loan is that with a home equity loan, you’ll begin repaying the loan as soon as you receive the funds.

With a HELOC, you’re only responsible for making interest payments during the draw period. Once you reach the repayment period, you’ll begin paying off the line of credit.

Loan Amount

The amount of money you receive for a HELOC or home equity loan depends on how much equity you’ve built up in your home. Most lenders will let you borrow up to 80% of the appraised value of the home. That means you’ll need at least 20% equity.

Interest Rates

When you’re comparing a HELOC vs. a home equity loan, the rates are one of the biggest differences.

Home equity loans are secured loans that typically have fixed interest rates, so your monthly payments will stay the same over the life of the loan. In comparison, HELOCs are also considered secured loans but come variable interest rates that are subject to market fluctuations. That means they could rise.

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Pros And Cons Of Home Equity Loans Vs. Lines Of Credit

Both home equity loans and HELOCs come with advantages and disadvantages. Understanding the pros and cons of each will help you determine which financing is best for your situation.

Home Equity Loan Pros

Here are some of the biggest benefits of taking out a home equity loan:

  • Fixed rates: You’ll receive a fixed interest rate, so your monthly payments will stay the same over the life of the loan. This will make it easier to budget for your payments and other expenses.
  • Low rates: Home equity loans come with lower interest rates than unsecured personal loans or credit cards.
  • Possible tax deduction: Your interest payments on your home equity loan may be tax-deductible.
  • Lump sum payment: You’ll receive a lump sum payment and will have the freedom to use the funds for any purpose.

Home Equity Loan Cons

While there are benefits to taking out a home equity loan, there are some drawbacks to consider:

  • Collateral requirements: Since your home is used as collateral for the loan, you risk losing your house if you fall behind on your payments.
  • Higher costs: Your monthly payments could be higher than what you received on your first mortgage, depending on the amount you borrowed and your interest rate. And you’ll have to pay closing costs, which could end up costing thousands of dollars.
  • Fixed rates: In most cases, receiving a fixed interest rate on a loan is a good thing. But if interest rates suddenly drop, you won’t be able to take advantage of them.

HELOC Pros

Here are the biggest advantages of taking out a HELOC:

  • Low APR: If you have good credit and a low DTI ratio, you may qualify for low interest rates. That means you’ll pay less money in interest over the life of the loan.
  • Borrow as needed: You’ll gain access to a revolving credit line and can borrow money as needed. And you’ll only have to pay interest on the money you end up spending.
  • Flexible repayment terms: You can take advantage of flexible repayment options, like interest-only payments during the draw period. And you may be able to choose to have your interest compounded only on the money you draw.
  • Possible tax deduction: Your interest payments on a HELOC may be tax-deductible if you use the funds for home improvements.

HELOC Cons

Here are some of the downsides of taking out a HELOC:

  • Variable rates: HELOCs come with variable rates, which means your interest rate will change periodically and could rise.
  • Possible fees: Some HELOCs come with prepayment fees, activation fees or an annual account maintenance fee.
  • Potential to overspend: You could be tempted to spend more money than you have, which can be a problem for some borrowers.
  • Risk of foreclosure: When you take out a HELOC, your home is used as collateral for the line of credit. So if you’re unable to keep up with the monthly payments, you risk losing your home.

When Should You Use A Home Equity Loan?

If you need to fund a project and have a clear idea of how much it’ll cost, you’ll probably want to apply for a home equity loan. And since a home equity loan comes with fixed rates, it’s a better choice for someone who wants to know how much their monthly payments will be.

When Should You Use A HELOC?

If you know you need to borrow money to cover an expense but aren’t sure how much you need, you may want to consider a HELOC. HELOCs are also a good choice for long-term projects since you’ll have access to an ongoing line of credit. Just make sure you’re okay with the interest rates and repayment terms you receive.

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The Bottom Line

If you’re trying to decide between a home equity loan and a line of credit, there are several things to consider. First, you should consider what you’ll use the funds for and how much money you need. Which type of financing will help you reach your long-term goals and stay within your budget?

Ultimately, you’ll have to evaluate your financial situation and determine the best choice for you. If you’re ready to , you can fill out an application today. 

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