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

Home Equity Loans vs. HELOCs: What’s the Difference?

A Home equity loan gives you a lump sum to pay back over a set period with fixed payments, while a HELOC works more like a credit card, allowing you to access funds as needed during a draw period before entering a repayment period. 

Both loan types can be a great way to tap into your home equity—the portion of your home’s value that you own outright. However, their ideal use cases and pros and cons differ slightly. Read on to learn how to choose between the two.

A Detailed Comparison of Home Equity Borrowing Options

Since both home equity loans and home equity lines of credit (HELOCs) involve borrowing against your house, they have much in common. 

For example, qualifying for either loan type generally requires having:

• At least 15-20% equity in your home (as assessed by an appraisal)
• A credit score of 680 or higher (though some lenders may allow lower scores)
• Proof of steady income (W-2 forms, tax returns, pay stubs, etc.)
• A debt-to-income (DTI) ratio of no more than 43%

Furthermore, both loan types typically let you borrow 60-85% of your home’s equity, come with 2-5% in closing costs, and require your home as collateral—meaning the lender could seize it if you default on the loan.

The key differences between the two loan types are how the lender disburses funds and how you repay them. Here’s a breakdown:

Understanding Home Equity Loans

A home equity loan is an installment loan. This means you get a lump sum upfront and agree to make equal monthly payments at a fixed interest rate for the duration of the loan. The loan terms can vary, but they are often from 5 to 30 years.

Common reasons to get a home equity loan include renovating your house, consolidating debt, covering an emergency expense, or funding a major life event like a wedding.

Understanding HELOCs (Home Equity Lines of Credit)

A home equity line of credit is a type of revolving credit. This means you can borrow up to a certain credit limit as needed, leaving the debt open-ended. 

However, a HELOC has two phases: a draw and a repayment period. During the draw period (usually 5-10 years), you can withdraw money, repay, and draw again within your available credit. Meanwhile, you’re only required to make interest payments on what you borrow. During the repayment period (usually 10-20 years), you can no longer withdraw money and must start making principal and interest payments until the loan is paid off.  

Furthermore, the interest rate on a HELOC is variable, meaning it fluctuates with the broader interest rate environment. This makes your total interest costs and the size of your payments (during both the draw and repayment phases) unpredictable, adding an extra layer of risk.

HELOCs can fund major expenses like home equity loans, but they’re better for unpredictable or spread-out costs —such as ongoing home renovations, medical bills, or tuition payments.

Navigating the Pros and Cons of Home Equity Loans and HELOCs

Naturally, home equity loans and HELOCs have their relative advantages and disadvantages:

Pros and Cons of Home Equity Loans

The Pros and Cons of Home Equity Loans Explained

• Lump sum: Get the full loan amount upfront to pay for a large expense.
• Fixed interest rate: Know your interest costs before you commit.
• Predictable payments: Know exactly what your payments will be to improve budgeting.

Cons of Home Equity Loans Explained 

• Less flexibility: You can’t borrow more without applying for a new loan or refinancing.
• Higher initial payments: Principal and interest payments are due from the start. 

Pros and Cons of HELOCs

Pros of HELOCs Explained

• Flexible draws: Only borrow what you need when you need it.
• Lower initial payments: Since you’re only charged interest during the draw period, your first payments are lower.
• Revolving credit: You can borrow, repay, and borrow again for ongoing credit access.

Cons of HELOCs Explained 

• Variable interest rate: If interest rates rise, so will the interest rate on your HELOC.
• Unpredictable payments: Your monthly payments can fluctuate due to the variable interest rate.

Your Guide to Choosing Between Home Equity Loans and HELOCs

If you’re debating between getting a home equity loan or a HELOC, consider your financial situation, preferences, and goals. 

For example, a home equity loan may be the way to go if you:

• Have a large, immediate expense to cover
• Know exactly how much money you need to borrow
• Prefer the stability of a fixed monthly payment

In contrast, a HELOC may be the better option if you:

• Don’t know how much you need to borrow
• Have to pay for ongoing, variable expenses
• Are good at controlling your spending despite constant access to credit

Once you’ve decided on a loan type, compare different lenders by carefully reviewing their loan terms, including interest rates and fees. Consider current market conditions, too. If interest rates are high and economic times are tough, you may not want to put your house on the line.

A few alternatives to home equity loans and HELOCs include:

• Cash-out refinances: Replace your existing mortgage with a new, larger loan so you can “cash out” the difference. 
• 401(k) loans: Borrow against your 401(k) retirement savings and repay with automatic paycheck withholdings. 
• Personal loans: Get an unsecured loan with fixed payments and a set term of 2-7 years. No collateral is required. 

The Bottom Line

Both home equity loans and HELOCs can be great ways to tap into your home equity, but the right choice depends on your needs. Weigh the pros and cons of each carefully, considering your financial situation, borrowing goals, and risk tolerance.