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    Taking A HELOC VS A Home Equity Loan: A Detailed Comparison

    Nathan J. Lee Profile
    Nathan J. Lee - 2020-10-04T21:00:00.000Z
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    If you need money to renovate your home or send your child to college and have equity in your home, you can tap into it to secure the financing you need. Yet, how do you decide between a home equity loan vs. a line of credit? Both are forms of equity financing, but differ in terms of repayment. Follow these tips to help you determine the best fit for your financial circumstances.

    What Is A Home Equity Loan?

    A home equity loan is a fixed-rate installment loan that is secured by your home. Like your original mortgage, you receive a lump sum upfront and repay the loan in equal monthly installments over a fixed term.

    The amount you can borrow depends on your credit score, the market value of your home, and your income. Typically, you’ll be limited to 85% of the equity in your home.

    There are pitfalls, so it’s essential to understand how a home equity loan compares to a line of credit.

    Pros

    • Access a large sum of money that can be used to cover major expenses, such as home renovation, unexpected tax bills, tuition, lawyers or other professional fees, and debt consolidation
    • Monthly payments are predictable
    • Interest rates are lower than other types of financing such as credit cards

    Cons

    • Closing costs can account for as much as 2% - 5% of the loan
    • If your home’s value decreases, you could end up owing more than your home is worth

    What Is A Home Equity Line Of Credit?

    The main difference between a HELOC and a home equity loan is how the loan funds are disbursed. A HELOC is a type of revolving credit, like your credit card. You’re approved for a credit limit, secured by your home. Interest is charged only on what you withdraw from your limit. However, unlike a home equity loan, a HELOC’s interest rate is usually variable.

    There’s usually an initial draw period of ten years, during which you are responsible for interest-only payments. At the end of this period, you can no longer draw from the HELOC and must begin making monthly payments toward interest and principal.

    Pros

    • Access a potentially large sum of money, but only repay the amount you use
    • The interest rate is lower than a credit card or other form of financing
    • Can be used to cover short-term expenses that you can quickly repay

    Cons

    • A HELOC is revolving credit like your credit card, making it easy to fall into the trap of overuse
    • If interest rates rise, your payments may become more than you can manage

    How To Find Out How Much Equity You Have In Your Home

    The way to find out how much equity you have in your home is to take your home’s current market value and subtract the amount you still owe on the mortgage. Your equity increases as the housing market improves and you continue to make your regular mortgage payments. 

    For example, imagine the original purchase price of your home was $225,000. Today your home is worth $300,000. The equity in your home increased by $75,000 simply due to prevailing conditions. To date, you’ve reduced your mortgage by $25,000, giving you a total of $100,000 in equity in your home. 

    As mentioned, most lenders cap the amount you can borrow at 85% of your equity. In this equation, you could borrow as much as $85,000.

    HELOC vs Home Equity Loan: Detailed Comparison

    Home Equity Line of Credit (HELOC)

    Home Equity Loan

    Variable-rate interest

    Fixed-rate interest

    Revolving credit

    Lump-sum payout

    Secured loan

    Secured loan

    10-20 year repayment term

    5-10 year repayment term

    A home equity loan is best when you need a large sum right away to cover major expenses or consolidate debt. By comparison, a home equity line of credit is best if you want to cover smaller expenses that’ll be spread out over several years.

    How To Decide Between A HELOC Or Home Equity Loan

    The decision between HELOC vs. home equity loans should rest on how much money you need and your financial lifestyle. Both options diminish the equity in your home. Your home is at risk whether you use a HELOC or home equity loan. If you fall behind on the payments, the lender can foreclose on your home.

    A home equity line of credit might be the better choice if:

    • You can handle fluctuating payments
    • You don’t need a lump sum upfront, but want the ability to borrow as you need
    • You’re confident that you can repay the HELOC before the initial draw period ends

    You might prefer a home equity loan if:

    • You like to budget fixed monthly payments
    • You want a fixed interest rate loan
    • You know how much money you need to cover an expense
    • You need to borrow a sum of money right away to fully pay for an upcoming expense
    • You want to consolidate debt, such as credit card debt

    The Bottom Line

    Home equity financing is a powerful tool for accessing a significant sum of money to cover major expenses. Understanding the difference between a HELOC and a home equity loan is key to making an informed decision as to which vehicle to use.

    To some extent, the choice really comes down to how you like to organize your financial habits. However, using your home as collateral is a riskier choice, so you’ll want to be sure you have the means to repay the loan.