When it comes to converting your home’s equity into usable funds, homeowners often must compare two main options: a home equity line of credit (HELOC) vs. a home equity loan, sometimes called a second mortgage.
Both financial products can provide you with the funds you need for major expenses, such as:
- Home renovations
- Debt consolidation
- Education
- Down payment on an investment property
- Emergency or other unplanned expenses
- Business ventures
- Student loans
- Medical expenses
- Weddings, family vacations, or other special events
However, understanding the differences between the two and determining which one is better suited to your needs can be challenging.
In this guide, we’ll explore and compare HELOCs vs home equity loans and show why a HELOC might be the better choice for most homeowners.
Understanding HELOCs and home equity loans
Before diving into the comparison, it’s important to understand what each of these financial products entails.
What is a HELOC?
A HELOC (home equity line of credit) is an ongoing, revolving line of credit secured by your home.
They work much like credit cards. You can borrow funds up to a specific limit during a predefined draw period—typically five to 10 years. During this timeframe, you can borrow, repay, and borrow again as needed.
Once the draw period is finished, you enter the repayment period, which usually lasts 10 to 20 years.
This is when you’ll repay the outstanding balance. HELOCs generally have variable interest rates, meaning your payments can fluctuate over time.
What is a home equity loan?
A home equity loan provides eligible borrowers with a one-time lump sum payment that they repay over a fixed term — usually 5 to 30 years.
Home equity loans come with a fixed interest rate. Your monthly payments remain consistent throughout your loan’s lifetime.
Unlike a HELOC, you cannot borrow additional funds once you receive the initial lump sum.
Key differences between HELOCs and home equity loans
Understanding the key differences between HELOCs and home equity loans can help you decide which option is better suited to your financial needs.
Flexibility
One of the most significant differences between a HELOC and a home equity loan is flexibility.
A HELOC allows you to borrow what you need (up to a set limit) when you need it during the draw period. This can be particularly beneficial if you have ongoing expenses or are still determining the total amount you need.
For example, if you’re planning a series of home renovations, a HELOC allows you to access funds incrementally as projects progress.
Home equity loans: Only one option to receive cash
In contrast, you have a single upfront lump sum payment with a home equity loan. This can be ideal for borrowers with a specific, one-time expense, such as a significant home repair or consolidating high-interest debts.
However, if you need additional funds, you must apply for a new loan, which can be time-consuming and potentially costly.
Interest rates
HELOCs typically offer variable interest rates, which can change over time based on market conditions.
While this means your payments could increase, it also allows you to take advantage of lower rates when they occur.
Some HELOCs offer an option to lock in a fixed rate on a portion of the borrowed amount, providing predictability in your payments.
Home equity loans
Home equity loans typically offer fixed interest rates, meaning consistent, monthly payments for the life of the loan.
However, fixed rates are generally higher than the initial rates offered on HELOCs, potentially costing you more in the long run.
Payment structure
The payment structure of HELOCs and home equity loans is another fundamental difference.
During your HELOC’s draw period, you may only be required to make interest-only payments, which can keep your initial payments low.
Once the repayment period begins, you must pay both principal and interest, which increases your monthly payments.
Home equity loans: Interest and principal need payments right away
Because a home equity loan is a one-time payment, you’ll start repaying both principal and interest — right from the beginning.
This creates consistent, predictable payments, but it also means higher payments than a HELOC’s interest-only phase.
Costs and fees
Both HELOCs and home equity loans come with various costs and fees, including:
- Appraisal fees
- Application fees
- Closing costs
However, HELOCs might have additional costs, such as annual or transaction fees, each time you draw from the credit line.
It’s essential to compare these costs when deciding which option is best for you.
Benefits of choosing a HELOC
While both HELOCs and home equity loans have advantages, a HELOC is often the superior choice for many homeowners due to its flexibility, potential cost savings, and adaptable payment structure.
Flexibility and convenience
A HELOC’s revolving credit line offers unparalleled flexibility. Like credit cards, you can ‘reuse’ the credit as needed during the draw period, making it ideal for ongoing projects or unexpected expenses.
This convenience is not available with a home equity loan—once you receive your cash, you’ll have to reapply if you need additional funds.
Potential for lower costs
HELOCs can be more cost-effective in the short term due to their variable interest rates and interest-only payment options during the draw period.
This can help keep your payments low initially, freeing up cash flow for other uses.
While there is the risk of interest rate increases, many borrowers find the initial savings a significant advantage.
Adjustable payment structure
The adjustable payment structure of a HELOC allows for greater financial flexibility.
During the draw period, making interest-only payments can help manage cash flow, especially if your income fluctuates.
You can pay down the principal during the draw period, reducing the amount you owe and potentially saving on interest.
HELOCs vs. home equity loans: The final verdict
When deciding between a home equity loan and a HELOC, consider your financial needs, goals, and the flexibility you require.
While both options have merits, a HELOC often stands out as the superior choice due to its flexibility, potential cost savings, and adaptable payment structure.
At HomeEQ, we are committed to helping you maximize your home’s equity with our competitive and convenient HELOC rates.