HELOC vs. Home Equity Loan: Comparing Equity Options

HELOC vs. home equity loan: Differences

A HELOC and a home equity loan are both ways to tap into your home’s equity, but they function quite differently. A HELOC is more like a credit card with a variable interest rate, allowing you to borrow what you need when you need it. In contrast, a home equity loan provides a lump sum with a fixed interest rate, which makes payments predictable.

Let’s break down these two options further to help you understand which might suit your needs better.

Home equity line of credit (HELOC)

• Credit limit with a borrowing period: You’re given a set credit limit and can borrow funds as needed, typically within a 10-year draw period.
• Flexible access to funds: You can withdraw money up to your limit, only paying interest on what you actually use.
• Variable interest rates: Most HELOCs have rates that can fluctuate based on market conditions, affecting your payment amounts.
• Interest-only payments during the draw period: Typically, you’re only required to make interest payments during the borrowing phase, with principal payments starting later.
• Repayment phase after borrowing ends: Once the draw period closes, you’ll enter a repayment phase where you pay back the remaining balance, often over 10 to 20 years. Payments will change based on the amount you draw and the current interest rate.

Home equity loan

• Fixed loan amount: You apply for a specific amount based on your needs and receive it in a lump sum.
• Fixed interest rate: The interest rate is locked in from the start, so your payments remain consistent throughout the life of the loan.
• Predictable monthly payments: Each payment is the same every month, covering both interest and a portion of the principal.
• Ideal for one-time expenses: This option is best suited for large, one-off expenses where you need a set amount of money upfront.
• Repayment over a fixed term: You’ll repay the loan over a predetermined period, typically five to 30 years, depending on the loan terms.

HELOC vs. home equity loan: Similarities

• Both are secured loans backed by collateral.
• Borrowed funds can be used as you desire.
• Both incur closing costs.
• Lenders typically allow you to borrow up to 85% of your home’s value, minus the balance of any existing mortgages.
• You may be eligible for tax benefits if the funds are used for qualified home improvements.
• Opening or using either loan can impact your credit score.
• Total costs* generally range from 2% to 5% of the loan or line of credit amount.

*While the costs may be similar, your closing costs will depend on your credit history, the lender, interest rates, and the property.

HELOC vs. home equity loan: Requirements

Both HELOCs and home equity loans require you to meet certain criteria to qualify, as they are secured loans backed by the equity in your home. While specific requirements can vary by lender, there are some general qualifications you’ll need to meet for either option:

• Sufficient home equity: Most lenders require that you have at least 15% to 20% equity in your home. This means your loan-to-value (LTV) ratio should be no higher than 80% to 85% after the new loan.
• Good credit score: You typically need a credit score of at least 620 for a HELOC or home equity loan, though a higher score can help you secure better terms and interest rates.
• Stable income and employment: Lenders will check your income and work history to make sure you can handle the monthly payments. They’ll want to see steady income and enough room in your budget to cover both your existing debts and the new loan.
• Debt-to-income ratio (DTI): Most lenders prefer a DTI ratio of 43% or lower. This means your monthly debt payments, including your potential new loan, should not exceed 43% of your gross monthly income.
• Property appraisal: An appraisal is usually required to determine the current value of your home and the amount of equity you have. This helps the lender assess how much you can borrow. However, there are some circumstances where a lender may not require an appraisal.

Meeting these requirements doesn’t guarantee approval, but it does give you a better chance of qualifying for a HELOC or a home equity loan. Additionally, stronger financials, like a higher credit score or lower DTI, may help you secure more favorable loan terms.

HELOC vs. home equity loan: Pros and cons

HELOC vs home equity loan: Best use cases

Choosing between a HELOC and a home equity loan depends on how you plan to use the funds, what your financial habits are, and how comfortable you are with variable interest rates. Each option has strengths for different situations.

Use a HELOC when…

You need flexible access to funds over time and want the ability to borrow only what you need, when you need it.

• You’re planning a long-term or phased home renovation: A HELOC lets you borrow money as you need it, so you don’t have to take out more than your project requires upfront.
• You’re investing in a rental property or side business: With a HELOC, you can tap into your available funds whenever the right investment opportunity comes along, without locking yourself into a large loan upfront.
• You want to minimize upfront repayment costs: If you’re trying to keep monthly costs down for a while, such as during a career change or after a big purchase, a HELOC’s interest-only payments during the draw period can give you some extra breathing room.

Use a home equity loan when…

You know exactly how much money you need and want predictable payments over a set term.

• You’re consolidating high-interest debt: A lump-sum loan with a fixed rate can make it easier to pay off credit cards or personal loans with one predictable monthly payment.
• You’re funding a one-time major purchase: Whether you’re covering a wedding, college tuition, or a new vehicle, fixed payments can make it easier to plan your budget and know what to expect each month.
• You’re locking in a low interest rate: If you find a good rate, a home equity loan can protect you from rising rates later and make your long-term payments easier to plan for.

»Learn more: Before deciding how to put your home equity to work, find out how much value you’ve built up in your property. HomeLight’s Home Equity Calculator can help you estimate your equity and take the guesswork out of choosing between a HELOC and a home equity loan.

HELOC vs. home equity: Loan examples

To better understand how a HELOC and a home equity loan work, let’s look at a simple example using the same house and the same amount of equity.

Imagine you have a home valued at $400,000, and you still owe $250,000 on your mortgage. This means you have $150,000 in home equity. Lenders typically allow you to borrow up to 85% of your home’s value minus the remaining mortgage balance.

In this case, 85% of $400,000 is $340,000. Subtract the $250,000 you owe, and you’re left with $90,000 as the maximum amount you can borrow.

$85,000 HELOC drawing $20,000

You decide to open a HELOC with a credit limit of $85,000, giving you access to this amount over a 10-year draw period. You initially draw $20,000 to cover a kitchen remodel.

• Draw period: During the first 10 years, you can borrow from the HELOC as needed. You only pay interest on the $20,000 you withdrew, not the full $85,000. With a variable interest rate, your payments may vary, but they are lower initially since you’re primarily paying interest.
• Repayment period: After the 10-year draw period, you enter a 10- to 20-year repayment phase. If you still owe $20,000 plus any interest, you’ll now make monthly payments that include both principal and interest until the balance is paid off.

$85,000 home equity loan

Instead of a HELOC, you opt for an $85,000 home equity loan to finance multiple home projects, including the kitchen remodel, a bathroom update, and a new roof.

• Lump sum disbursement: You receive the entire $85,000 upfront in a single payment, which you use to fund the home improvements.
• Fixed interest rate: The loan comes with a fixed interest rate, so your monthly payments are consistent and predictable over the term of the loan, which could be 15 years, for example.
• Repayment schedule: Each month, you make equal payments that cover both interest and a portion of the principal, giving you a clear path to pay off the loan within the 15-year term.

Both options let you borrow against your home’s equity, but the right choice depends on how you want to use the money. A HELOC gives you flexible access to funds over time, while a home equity loan gives you a lump sum upfront for bigger expenses.

Using equity to buy before you sell

If you’re considering using your home equity to purchase your next home, HomeLight’s Buy Before You Sell program is a better alternative to a second mortgage. It can streamline and simplify the buy-sell process, allowing you to unlock your equity to make a strong offer on your new home while avoiding the stress of timing the sale of your current home.

HomeLight’s program gives you the flexibility to move on your own timeline, so you can focus on settling into your new home without the stress of rushing the process. Here’s a quick look at how HomeLight’s Buy Before You Sell works:

HELOC vs. home equity loan: Which is right for you?

Choosing between a HELOC and a home equity loan comes down to what your financial goals are and how you plan to use the money. Here’s a quick look at what makes each option different:

HELOC: If you want the flexibility to borrow money as expenses come up, a HELOC can be a good fit. You can take out funds when you need them instead of borrowing everything at once, and you may have lower payments during the draw period. Just remember that HELOCs usually come with variable interest rates, so your payments can change over time.

Home equity loan: If you need a set amount of money for a big expense and want predictable payments, a home equity loan may make more sense. You’ll get a lump sum upfront, and the fixed interest rate means your monthly payments stay the same, making it easier to budget and know when you’ll have the loan paid off.

Think about what you need the money for, how much equity you have, and whether you’re more comfortable with payments that can change or stay the same. Talking with a financial advisor can also help you compare your options and choose the loan that fits your long-term plans.

And before choosing a loan option, it helps to know how much equity you actually have available. Use HomeLight’s Home Value Estimator to get a better idea of your home’s current value and see how much borrowing power you may have.

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