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

Amy Fontinelle has more than 15 years of experience covering personal finance, corporate finance and investing.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Vikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.

Tapping Your Home Equity

1. HELOC (Home Equity Line of Credit) and Home Equity Loan: Comparing Your Options
2. Home Equity Definition
3. Calculating Your Home Equity
4. Smart Ways to Tap Home Equity
5. Home Equity Loan vs. HELOC

Home Equity Loan

1. Home Equity Loan Definition
2. Home Equity Loan Basics
3. Tax Loophole for Home Equity Loan Interest
4. Refinancing Your Home Equity Loan

Home Equity Line of Credit

1. Should You Choose a HELOC?
2. The HELOC Fixed-Rate Option
3. Reasons Not to Use a HELOC
4. When HELOCs Can Hurt You
5. Protect vs. HELOC Fraud
6. Is HELOC Interest Tax Deductible?
7. Options for Refinancing Your HELOC

Home Equity Loans vs. HELOCs: An Overview

Home equity loans and home equity lines of credit (HELOCs) are both secured by the borrower's home, and they usually have much more attractive interest rates than personal loans, credit cards, and other unsecured debt. But they can also be risky. The best home equity product for you will depend on your needs, goals, and spending habits. Let's take a look at how these two products differ.

Key Takeaways

• Home equity loans and home equity lines of credit (HELOCs) are both based on a borrower's equity in their home.
• A home equity loan comes with fixed payments and a fixed interest rate for the loan term.
• HELOCs are revolving credit lines with adjustable interest rates and, as a result, variable minimum payment amounts.
• The draw periods of HELOCs allow borrowers to withdraw funds from their credit line as long as they make interest payments.
• After the draw period, full repayment of both principal and interest begins.

How a Home Equity Loan Works

A home equity loan is a fixed-term loan made by a bank or other lender to a borrower based on the equity in their home. Borrowers apply for a set amount and, if approved, receive it in a single lump sum. A home equity loan has a fixed interest rate and a fixed payment schedule for the entire loan term. It is sometimes called a home equity installment loan or an equity loan.

To qualify for one of these loans, you need to have enough equity built up in your home. Lenders use various formulas to determine that, such as your combined loan-to-value (CLTV) ratio. You can usually borrow up to 80% of your equity in the property.

As mentioned, a home equity loan's interest rate is fixed for the life of the loan, much like a fixed-rate first mortgage. The monthly payments are also fixed, split into equal amounts over the life of the loan. Portions of each payment go to the loan's interest and principal.

The repayment term generally ranges between five and 30 years. Whatever the period, home equity loans have stable, predictable monthly payments, making them relatively easy to budget for.

• Fixed amount, making impulse spending less likely
• Fixed monthly payments make it easier to budget
• Lower interest rate than many other loans

• Can't take out more for an emergency without getting another loan
• Have to refinance to get a lower rate
• May lose your home if you default

To calculate your home equity, estimate the current value of your property by looking at a recent appraisal or using the estimated value tool on a website like Zillow, Redfin, or Trulia. Be aware that these estimates may not be 100% accurate. Subtract the total amount you owe on your home from that figure to get your equity.

How a Home Equity Line of Credit (HELOC) Works

A home equity line of credit is a form of revolving credit that allows a borrower to take out money up to a preset credit limit, make payments, and then withdraw money again if they haven't reached their limit. Like home equity loans, they are secured by the equity in your home.

A HELOC's credit line remains open until its term ends, allowing you to use it as needed as long as you make your minimum required payments. Those payments will vary based on your outstanding balance at the time.

HELOCs typically have variable interest rates that can increase or decrease over the years, although fixed-rate HELOCs are sometimes available. The initial rate that a lender might offer you will depend on your creditworthiness and how much money you're asking for.

HELOC terms have two phases:

1. The draw period. During this phase you can withdraw funds whenever you wish, up to your agreed-upon credit limit. When the draw period ends, you cannot borrow any more money. A draw period might, for example, last for 10 years, during which you may make interest-only payments.
2. The repayment period. In this phase you must repay the loan in full, including both principal and interest. A repayment period might, for example, extend over 20 years.

It's important to note that the transition from interest-only payments to full, principal-and-interest payments can be quite a shock, and borrowers need to budget for those increased monthly payments. It's also important to remember that while HELOCs work much like credit cards, because they are secured by your home you could face foreclosure if you're unable to keep up with the payments. Most credit cards, by contrast, are unsecured.

• Choose how much (or little) to use of your credit line
• Variable interest rates mean rates and payments may drop based on market conditions
• Lower interest rate than unsecured loans
• Credit line available for emergencies

• Harder to budget because of fluctuating interest rates
• Variable interest rates mean rates and payments may rise based on market conditions
• May lose your home if you can't make payments
• Easy to impulse-spend up to your credit limit

Deciding Which One Is Better for You

Both home equity loans and HELOCs allow you to borrow money for any purpose you have in mind. But depending on your situation, one may be more appropriate than the other.

Compared with a home equity line of credit, a home equity loan may be a better option if you:

• Face a single large expense for which you need a set amount of cash.
• Like the idea of fixed monthly payments for which you can budget.
• Might be prone to overspending if you had ongoing access to extra cash.

For example, a home equity loan could be the right choice if you need money for a new roof or kitchen remodeling project, a wedding, or to pay off high-interest debts, such as credit cards.

Compared with home equity loans, HELOCs are a potentially better option if you:

• Expect to need money for a series of purchases over an extended period of time.
• Aren't sure how much you'll need to borrow in total.
• Are comfortable with the fact that your interest rate and required payments can change.

For example, a HELOC might be the better choice if you are planning a series of home renovations or if you face years of college tuition bills. It could also be useful if you want to make sure you'll have some money available in an unexpected emergency.

Note that getting a good HELOC may be tougher today than it was a few years ago. In 2020, two major banks—Wells Fargo (WFC) and JPMorgan Chase (JPM)—put a freeze on new HELOCs and haven't resumed offering them as of this writing (July 2024).

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on characteristics like race, religion, sex, or age, file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).

Is the Interest on a Home Equity Loan or HELOC Tax Deductible?

Under current law, the interest you pay on a home equity loan or HELOC is tax deductible only if the loan is secured by your main home or a second home and, as the Internal Revenue Service puts it, is "used to buy, build, or substantially improve the residence." However, that law is set to expire in 2025, after which the rules may change. Under the pre-2018 rules, the interest was tax deductible regardless of how you used the money.

Which Gets You Money Faster: a HELOC or Home Equity Loan?

If you need money as quickly as possible, a HELOC might be the better bet. Many lenders advertise home equity loan processing timelines of around 55 days, whereas some say their HELOCs can close in as little as two weeks, although they may take up to six.

What Is a Good Alternative to a HELOC or a Home Equity Loan?

If you need a large lump sum for a fixed expense you might consider a cash-out refinance (if you have sufficient equity in your home) or a loan from your 401(k) (if your employer allows it). If you want short-term access to a credit line with a low interest rate, a credit card with a 0% annual percentage rate (APR) for a certain introductory period could be an option, provided that you can pay it off before that rate expires. If you don't mind slightly higher interest rates and want to avoid the risk of foreclosure, a personal loan could be a worthy alternative. Each option has pros and cons that should be considered carefully.

What Are the Requirements for a HELOC or a Home Equity Loan?

For either a HELOC or a home equity loan borrowers will generally need:

• More than 20% equity in their home
• A credit score of 680 or higher
• Stable, verifiable incomes
• A debt-to-income ratio of no more than 43%

It is possible to get approved without meeting these requirements by going through lenders that specialize in high-risk borrowers, but expect to pay much higher interest rates. If you are a high-risk borrower, it may be a good idea to seek out a credit counseling service for advice before signing up for a high-interest HELOC or home equity loan.

The Bottom Line

Home equity loans offer the stability and predictability of fixed rates and payments, while HELOCs provide ongoing access to money when you need it. As with any credit product, it's important not to get overextended and borrow more than you can pay back, especially when you're putting your home on the line.

1. Federal Trade Commission, Consumer Advice. "Home Equity Loans and Home Equity Lines of Credit."
2. Discover Home Loans. "How Do Home Equity Loans Work: Rates, Terms and Repayment."
3. Bank of America. "Home Equity Assumptions."
4. Chase. "Get the Money You Need for Your Goals."
5. Wells Fargo. "New Home Equity Lines of Credit Are Currently Unavailable."
6. U.S. Department of Housing and Urban Development. "Housing Discrimination Under the Fair Housing Act."
7. Internal Revenue Service. "Question: Is Interest Paid on a Home Equity Loan or a Home Equity Line of Credit (HELOC) Deductible?"
8. Experian. "What Credit Score Do I Need to Get a Home Equity Loan?"

Tapping Your Home Equity

1. HELOC (Home Equity Line of Credit) and Home Equity Loan: Comparing Your Options
2. Home Equity Definition
3. Calculating Your Home Equity
4. Smart Ways to Tap Home Equity
5. Home Equity Loan vs. HELOC

Home Equity Loan

1. Home Equity Loan Definition
2. Home Equity Loan Basics
3. Tax Loophole for Home Equity Loan Interest
4. Refinancing Your Home Equity Loan

Home Equity Line of Credit

1. Should You Choose a HELOC?
2. The HELOC Fixed-Rate Option
3. Reasons Not to Use a HELOC
4. When HELOCs Can Hurt You
5. Protect vs. HELOC Fraud
6. Is HELOC Interest Tax Deductible?
7. Options for Refinancing Your HELOC

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