If you own a home with some equity, consider a home equity loan or a home equity line of credit (HELOC) to help fund your next big purchase or renovation. While you can use the value of your property as collateral for either of these loans, some important distinctions between them could make one a better match for your financial circumstances than the other.
We’ll examine the differences between HELOCs and home equity loans in this article and assist you in selecting the option that is best for you.
When deciding between a HELOC and a home equity loan, it’s crucial to consider your credit score, income, and debt-to-income ratio.
A home equity line of credit (HELOC) is a revolving credit line that allows you to borrow against the equity in your home. It’s comparable to a credit card in that your house is used as collateral. A HELOC allows you to borrow up to a particular amount, known as your credit limit, and only pay interest on the amount borrowed.
How a HELOC works
When you get a HELOC, you will be given a credit limit, the most money you can borrow. This credit line is available for use up to your credit limit as needed. Once you repay the borrowed money, your available credit will rise again, enabling you to borrow additional money if necessary.
HELOCs often have variable interest rates, which means that the rate may go up or down over time. This is a crucial point to keep in mind. This can make it impossible for some borrowers to accurately anticipate how much interest they’ll pay each month.
Advantages of a HELOC
A HELOC has the following benefits over a home equity loan:
- Flexibility: A HELOC gives you more freedom to borrow only what you need at the time you need it. If you have recurring costs, like house renovations or college tuition, that you’ll be paying for over time, this may be a suitable alternative.
- Reduced upfront expenses: If you need to borrow a smaller amount of money, HELOCs may be a more economical alternative because they often have fewer upfront costs than home equity loans.
- Reduced interest rates: Compared to home equity loans, HELOCs frequently feature lower interest rates, which can help you save money over time.
Disadvantages of a HELOC
When selecting a HELOC, there are a few drawbacks to take into account as well:
- Variable interest rates: As was already said, HELOCs frequently have fluctuating interest rates, making it challenging to anticipate precisely how much interest you will pay each month.
- Uncertainty of future borrowing costs: Future borrowing expenses are uncertain because the interest rate on a HELOC might fluctuate over time. As a result, it can take time to estimate how much interest you will pay throughout the loan.
Home equity loans
In contrast, a home equity loan is a lump sum loan that lets you borrow against the equity in your property. With a home equity loan, you’ll get a predetermined sum of money upfront and have a certain amount of time to pay it back with interest.
How a Home Equity Loan Works
When you obtain a home equity loan, you will receive a lump sum of money you can spend for whatever purpose. The loan will have predetermined monthly payments that you must make that cover both the principal and interest.
A home equity loan might be a better choice if you have a specific expense you need to pay for, such as a home renovation or medical bills, because, unlike a HELOC, you won’t be able to borrow extra money after you’ve received the lump sum.
Advantages of Home Equity Loans
A home equity loan has the following benefits over a HELOC:
- Fixed interest rates: Home equity loans frequently have fixed interest rates, which implies that your monthly payments will remain constant throughout the loan’s term. Making a budget and planning for your monthly costs may become simpler.
- Certainty of future borrowing costs: A home equity loan’s fixed interest rate means that you will always be aware of the total interest you will pay throughout the loan. This may be in your favor if you value stability and predictability in your financial life.
- Suitable for specific expenses: Because you get a lump sum upfront, a home equity loan can be a good choice if you have a particular expense you need to pay for, such as significant home remodeling or medical bills.
Disadvantages of a Home Equity Loan
Yet, there are several drawbacks to consider when selecting a home equity loan:
- Less flexibility: If you receive your entire loan amount up front with a home equity loan, you can only borrow money if you do.
- Higher upfront costs: If you need to borrow a smaller amount of money, home equity loans may be a less inexpensive option because they often have higher upfront costs than HELOCs.
- Higher interest rates: Home equity loans frequently have interest rates that are higher than HELOCs, which makes them potentially more expensive over time.
Comparison Table: HELOC vs. Home Equity Loan
|Feature||HELOC||Home Equity Loan|
|Borrowing period||Draw period plus repayment period||One-time lump sum|
|Payment structure||Interest-only during the draw period, then principal and interest during repayment period||Principal and interest from the start|
|Flexibility||Can borrow only what you need, when you need it||One-time lump sum|
|Upfront costs||Lower than home equity loans||Higher than HELOCs|
|Uses||Ongoing expenses, like home improvements or college tuition||Specific, one-time expenses, like a medical bill or a home renovation project|
|Risk||Variable interest rate can lead to higher payments||Fixed interest rate means payments remain the same|
|Interest deduction||Tax deductible in most cases||Tax deductible in most cases|
Which Is Right For You?
You might be wondering which choice is best for you now that we’ve discussed the variations between HELOCs and home equity loans. Your unique financial circumstances and ambitions ultimately determine the best option.
A HELOC might be a suitable choice if you want more flexibility to borrow what you need and have ongoing expenses like home renovations or college tuition. But a home equity loan might be a better option if you have a specific expense you need to pay for, such as significant home remodeling or medical expenses, and you want the security of fixed monthly payments.
When deciding between a HELOC and a home equity loan, it’s crucial to consider your credit score, income, and debt-to-income ratio. To assist you in choosing the best course of action for your circumstances, you should speak with a financial advisor or a loan officer.
- While a HELOC allows you to take out loans as needed, a home equity loan gives you a significant sum of money upfront.
- Most HELOCs have interest rates that change over time, while most home equity loans have fixed interest rates.
- A HELOC may permit interest-only payments during the draw period, as opposed to a home equity loan that requires fixed monthly payments for the duration of the loan.
- Home equity loans are good for specific, one-time needs, while a home equity line of credit (HELOC) is better for recurring costs or costs with a range of possible costs.
- A HELOC often has lower upfront expenses than a home equity loan.