If you’re thinking about tapping the equity in your home, you’re looking at either a home equity loan or a home equity line of credit, better known as a HELOC. Both may allow you to borrow a large sum at a relatively low interest rate and with lower fees than a mortgage refinance.
Either a home equity loan or a HELOC is a second mortgage, so you’re betting the house: Your home can be foreclosed on if you cannot make payments. But for homeowners who have a secure income, good credit, and a substantial amount of equity, either one can be an excellent way to fund big expenses like renovations and debt consolidation.
When looking at a HELOC vs. a home equity loan side by side, there are differences that mean one type of loan may make more sense than the other to you. Let’s take a deep dive into the two to help you decide.
What’s the Difference Between a HELOC and Home Equity Loan?
A HELOC is a revolving line of credit. You can take out money as you need it, up to your approved limit, during the draw period. You may be able to make interest-only payments on the amount you withdraw during that time, typically 10 years.
After the draw period comes the repayment period, usually 20 years, when you must repay any principal balance with interest.
Most HELOCs have a variable interest rate. Some have a low introductory rate, and some require minimum withdrawal amounts.
A home equity loan is another type of second mortgage that uses your home as collateral, but in this case, the funds are disbursed all at once and repayment starts immediately. It is usually a fixed-rate loan of five to 30 years, and monthly payments remain the same until the loan is paid off.
The main differences between the two are how the money is disbursed, how it is repaid, and how the interest rate works.
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Key Differences
| HELOC | Home equity loan | |
|---|---|---|
| APR | Typically variable | Typically fixed |
| Repayment | Repay only the amount borrowed, and may have the option to pay interest only in the draw period | Repayment starts immediately at a set monthly payment |
| When are funds disbursed? | Funds are disbursed as you need them | Funds are disbursed all at once |
| Loan type | Revolving line of credit | Installment loan |
Comparing HELOCs and Home Equity Loans
Homeowners usually will need to have 15% to 20% equity in their home — the home’s market value minus what is owed — to apply for a home equity line of credit or home equity loan.
If you do, then how much home equity can you tap? Most lenders will require your combined loan-to-value ratio — combined loan balance / appraised home value — to be 90% or less, although some will allow you to borrow 100% of your home’s value.
Here’s what to look for when comparing a HELOC with a home equity loan.
Interest Rate
The interest rate for a home equity loan is typically fixed, while the interest rate for a HELOC is usually variable.
HELOC rates tend to be a little higher than home equity loan rates (but keep in mind that you may pay interest only on what you borrow from the credit line). The exception is a low teaser rate that may be offered for six months to a year before converting to a variable rate.
Keep in mind that Federal Reserve decisions affect the rates for both products. The prime rate, the rate given to low-risk borrowers for prime loans, is based on the federal funds rate set by the Fed.
Even as home equity loan rates rise, though, the rate for these secured loans will be lower than that of almost all unsecured personal loans and credit cards.
Recommended: What to Learn From Historical Mortgage Rate Fluctuations
Costs
Closing costs are essentially the same for a HELOC and a home equity loan — 2% to 5% of the total loan amount — but many lenders offer to reduce or waive them.
Lenders may have already baked their costs into your rate quote.
You’ll want to shop for the best deal, comparing rates, upfront costs, closing costs, and fees. Bear in mind that advertised rates are often reserved for well-qualified borrowers, so read the fine print.
Requirements
To qualify for a HELOC or home equity loan, lenders will look at your employment and credit history, income, and the appraised value of your home. In other words, you must:
• Have enough equity in your home
• Have enough income to cover the monthly payment on the home equity loan
• Have a good credit score (typically 680 or over, though many lenders prefer 700-plus)
• Have a debt-to-income ratio of 36% to 50%
Repayment
When it comes to repayment, HELOCs and home equity loans are very different.
With a home equity loan, the entire loan amount is deposited into your account at once. This also means you’ll start paying on the loan immediately.
With a HELOC, you use funds as you need them, up to the limit, during the draw period. Your payment may be just the interest charge for the amount borrowed. The revolving credit line means you can withdraw money, repay it, and repeat before the repayment period, when the draw period ends and principal and interest payments begin.
Money Disbursement
Funds for a home equity loan are disbursed immediately. Sums from a HELOC are withdrawn as needed.
Payments
Payments on a home equity loan begin immediately. Payments on a HELOC aren’t required until you start borrowing money from your credit line.
HELOC vs Home Equity Loan: Pros and Cons
HELOC Pros and Cons
HELOC Pros and Cons
Pros:
• Access up to 90% of your home equity and sometimes more
• Flexible use
• Only borrow what you need
• Lower interest rate than most unsecured loans or credit cards
• Some have low introductory APR offers
• Loan interest may be tax deductible if the borrowed money was used to buy, build, or substantially improve your primary home (also true of home equity loans)
Cons:
• May have a slightly higher interest rate than a home equity loan
• Variable interest rate means your rate and monthly payment can change throughout the repayment period
• Home is at risk of foreclosure if you’re unable to make payments
• The repayment period could bring sticker shock
• Paying off a loan balance early could trigger a prepayment penalty, and closing a credit line within a predetermined period — usually three years — could negate the waiving of closing costs
• In a small number of cases, a balloon payment could be required at the end of the draw period
May include annual or inactivity fees
Home Equity Loan Pros and Cons
Pros:
• Access up to 90% of your home equity and sometimes more
• Funds disbursed at once
• Fixed interest rate
• Predictable monthly payments
• Lower interest rate than unsecured loans
Cons:
• Home is at risk of foreclosure if you’re unable to make payments
• No flexibility in the amount of money you get
• Limited to fixed installment payments
Which Is Better, HELOC or Home Equity Loan?
The better loan is the one that fits your life circumstances. A home equity line or loan can be used to buy a second home or investment property, pay medical bills, pay off higher-interest credit card debt, fund home improvements, and pay for other big-ticket items.
When a HELOC Is a Better Fit
HELOCs are more flexible than home equity loans. If you’re unsure how much money you need, don’t need to borrow immediately, or want flexible repayment options, you might want to think about applying for a HELOC over a home equity loan.
When a Home Equity Loan Is a Better Fit
A home equity loan is great for people who know how much they need to borrow and want the regularity of an installment loan with a fixed interest rate and fixed payments.
The Takeaway
Deciding on a home equity loan vs. a HELOC can depend on what you’re planning to use the money for. If you need a certain amount of money all at once, a home equity loan may be a good fit. If you want the flexibility to take out money as you need it, a HELOC may work better.
A HELOC brokered by SoFi may be just the right thing, right now for your situation. Access up to 90%, or $500,000, of your home equity for almost any need.
FAQ
Which is faster, a HELOC or home equity loan?
They’re tied, on average. It could take two to six weeks to get a HELOC or home equity loan.
HELOC or home equity loan for an investment property?
Investors may like the flexibility of a HELOC. A lump-sum home equity loan, however, could also be advantageous for renovating or buying properties.
HELOC or home equity loan for a home remodel?
If you know exactly how much you’re going to be spending on a home remodel and you’d like predictable payments, you can use a home equity loan. If you want more flexibility or are less certain about your costs, you may like the flexibility of a HELOC.
Can you have both a HELOC and home equity loan?
It is rare to have both a HELOC and a home equity loan. One would be a second mortgage and the other would be a third mortgage. Few banks are willing to lend money on a third mortgage, and for any that do, the interest rate would be high.
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