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

Home equity lines of credit (HELOCs) and home equity loans (HELOANs) are both viable borrowing options for homeowners who have built equity in their property. However, their structure, benefits and ideal use cases differ significantly.

If you’re considering borrowing against the value you’ve built in your home, you’ll need to know exactly how they work, their differences, and which works best for you.

HELOC vs a home equity loan: Key differences

Choosing between a HELOC and a home equity loan is a common decision among borrowers and it often depends on individual finances and circumstances.

A home equity line of credit offers revolving credit for a set period, allowing you to borrow as needed, up to the approved limit. In contrast, a home equity loan provides a lump sum with fixed repayment terms.

Depending on your financial situation, one may work better than the other. HELOCs provide greater flexibility, with credit available on an as-needed basis, while a home equity loan offers a conventional loan structure that is typically more predictable and easier to navigate.

Comparing HELOCs and home equity loans

Here’s a comparison of HELOCs and home equity loans, highlighting the key differences between the two.

Source ^[1]

What is home equity?

Home equity is your property’s market value minus any debt on your home, such as the mortgage. Homeowners typically first gain equity by putting a down payment on their home and then build equity over time through monthly mortgage payments, however, home equity can fluctuate due to factors such as changes in the market, the condition of the local area and improvements made to your home.^[2]

How a Home Equity Loan (HELOAN) works

A home equity loan is similar to a traditional loan, providing you with a lump-sum payment at a fixed interest rate, repaid over a fixed term. This loan uses the equity you have in your home as collateral.

Most lenders may require that you have already paid off at least 15% to 20% of your home’s total value to qualify. Generally, lenders will borrow no more than 80% of the equity that you have put into your home.^[2]

The fixed terms and conditions might be more suited to budget accordingly, with predictable monthly payments.

Loan terms typically range from 5-30 years depending on the lender’s requirements.^[3]

Home equity loan pros and cons

The advantages and disadvantages of home equity loans should be considered before you apply.

Here are the pros and cons to be aware of:

Pros:

• Predictable monthly payments protect you from interest rate fluctuations.
• The lump-sum payment can cover your expense all at once.
• Structured payments allow for easier budgeting.

Cons:

• No flexibility as you’re unable to borrow more once the has been disbursed.
• With an interest rate that is fixed, home equity loans tend to have a higher rate than HELOCs.
• As with any home mortgage loan or equity loan, if you cannot make your monthly payments, you put your home at risk of foreclosure.
  ^[1][2]

How a Home Equity Line of Credit (HELOC) works

A home equity line of credit is a revolving line of credit during the draw period, with variable interest rates and a repayment period between 10-20 years.

A HELOC uses your home as collateral just like a home equity loan. Unlike home equity loans, HELOCs offer flexibility, allowing you to go back to your credit as spending needs arise (up to the limit on your line of credit).

This type of credit can be especially useful for those that need great payment flexibility.^[2]

You can access funds during what’s known as the “draw period” before entering a repayment period, this is where you can withdraw money, repay, and draw again within your available credit.^[4]

What is a draw period?

A draw period is the timeframe (usually 5-10 years) during which you can access and use funds from your HELOC, up to the agreed credit limit. Once this phase comes to a close, you’re no longer able to borrow funds from your HELOC and will need to begin the repayment period.^[4]

What is the repayment period?

The repayment period is the phase (usually 10-20 years) following the draw period of a HELOC, during which you must repay the remaining balance in full, including both the principal and any accrued interest.

Repayment phases typically last up to 20 years, and borrowers are required to make regular monthly payments until the balance is settled.^[4]

HELOC pros and cons

It’s important to know about the pros and cons of HELOCs before applying, here are the main ones to be aware of:

Pros:

• Borrow the funds as you need them during the draw period (up to the approved limit).
• Get lower initial payments during the draw period, typically not paying back the principal.
• The flexibility allows you to have unpredictable expenses covered over time.

Cons:

• The variable interest rates mean that prices can rise.
• The repayment costs can change making it more challenging to budget.
• As with any home mortgage loan or equity loan, if you cannot make your monthly payments, you put your home at risk of foreclosure.
  ^[1][2]

HELOC and home equity loan requirements

To gain approval for a HELOC or home equity loan, you’ll typically need to meet the following requirements:

• 15%-20% equity in your home (both loan types typically let you borrow 60-85% of your home’s equity).
• A credit score of 680 or higher (some lenders may allow lower scores in the mid-600s).
• A sufficient income that can be verified (w-2 forms, tax returns, pay stubs, etc.).
• Debt-to-income ratio that doesn’t exceed 43%.
  ^[6][2]

Which is a better option for you?

Both home equity loans and HELOCs allow you to borrow against the equity in your home, but choosing the right option depends on your financial situation and goals.

When a home equity loan could suit you

A home equity loan is ideal for an upfront, lump-sum payment. Here are some examples of situations where people may choose a home equity loan over a HELOC:

• One-time, large expense: If you’re having a major home renovation such as a new roof, extension or kitchen remodel and know the amount required, you can make the payment in one with a home equity loan.
• Work better with predictable payments: Those who prefer working to a monthly budget may prefer the consistent and predictable monthly repayments.
• Consolidate high-interest debts: A HELOAN can be an option to consolidate debts. For example, paying off $20,000 credit card debt with a lower, fixed interest rate.
  ^[4]

When a HELOC could suit you

A HELOC works best for those requiring a flexible borrowing option. Here are some examples for when a HELOC may suit you:

• Gradual home renovation: Completing phased home improvement projects, such as upgrading the interior or making multiple fixes and repairs may require access to funds over time.
• Covering recurring costs: Whether it’s medical bills for ongoing treatment or tuition fees, a revolving credit line’s flexibility can provide peace of mind.
• Starting a new business: Launching a business involves significant setup costs and plenty of unexpected expenses along the way, meaning a HELOC could be a suitable option.
  ^[7]

Frequently Asked Questions (FAQs)

Is it harder to sell a house with HELOC?

HELOCs do not make selling your house more difficult but you must pay off the remaining balance at closing. It's important to prepare for this when planning the sale of your home.^[8]

Can I switch from HELOC to a home equity loan?

Yes, you can refinance your HELOC into a home equity loan if you’d prefer fixed payments or a stable interest rate. There are multiple ways to refinance, making it best to explore options before committing.^[9]

Which option is better for home renovations?

Both borrowing options are ideal for home renovation plans. If you know the amount your project will cost, a home equity loan works best with the fixed rate and repayment period but if you are planning for a phased home improvement and unpredictable costs, a HELOC could be your best option.

Does a HELOC or home equity loan have higher rates?

A home equity loan has a fixed interest rate, and is more likely to have higher interest rates but they’re countered by the fact the rates are fixed. With HELOCs variable rates they’re subject to fluctuation as you borrow.^[2]

Sources

1. Bank of America. “Home Equity Loan vs. Line of Credit? Here’s what you need to know” https://www.bankofamerica.com/mortgage/learn/home-equity-loan-vs-line-of-credit.
2. Equifax. “Home Equity Loan vs. Home Lines of Credit (HELOC)” https://www.equifax.com/personal/education/loans/articles/-/learn/home-equity-loans-vs-home-equity-lines-of-credit.
3. Discover. “How do home equity loans work: Rates, terms and repayments” https://www.discover.com/home-loans/articles/how-home-equity-loans-work-rates-terms-repayment.
4. Investopedia. “Home Equity Loan vs HELOCs: What’s the Difference” https://www.investopedia.com/mortgage/heloc/home-equity-vs-heloc.
5. Bank of America. “Home Equity Assumptions” https://www.bankofamerica.com/home-equity/assumptions-home-equity.
6. Experian. “Requirements for a Home Equity Loan or HELOC” https://www.experian.com/blogs/ask-experian/requirements-for-home-equity-loans-and-helocs.
7. Bankrate. “Best uses for a home equity line of credit (HELOC)” https://www.bankrate.com/home-equity/best-uses-for-a-home-equity-line-of-credit-heloc.
8. Experian. “Can You Sell Your House if You Have a HELOC?,” https://www.experian.com/blogs/ask-experian/can-you-sell-house-if-you-have-heloc.
9. Bankrate. “Ways to refinance your HELOC,” https://www.bankrate.com/home-equity/ways-to-refinance-heloc.

About the author

Becca has over 10 years of experience as a content writer, working across various industries including finance, digital marketing, education, travel, and technology. Her work has been featured in publications including Forbes, Business Insider, AOL, Yahoo, GOBankingRates, and more.

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