A home equity loan provides a lump sum at a fixed interest rate with predictable monthly payments. A HELOC (Home Equity Line of Credit) works like a credit card—you draw money as needed during a 10-year draw period, typically at a variable rate. Choose a home equity loan for one-time expenses like renovations. Choose a HELOC for ongoing or unpredictable expenses.
How Home Equity Loans Work
A home equity loan is a second mortgage that gives you a lump sum upfront.
Key Features
- Lump sum: Receive all funds at closing
- Fixed rate: Interest rate never changes
- Fixed payment: Same monthly payment for entire term
- Terms: Typically 5-30 years
- closing costs: 2-5% of loan amount
How It Works
- Apply and get approved based on equity, credit and income
- Receive full loan amount at closing
- Begin repaying immediately with fixed monthly payments
- Pay off completely at end of term
Example Home Equity Loan
Marcus has $150,000 in equity. He takes a $50,000 home equity loan:
- Interest rate: 8.5% fixed
- Term: 15 years
- Monthly payment: $492
- Total interest paid: $38,560
His payment stays $492 for all 15 years, regardless of market rate changes.
How HELOCs Work
A HELOC is a revolving line of credit secured by your home.
Key Features
- Credit line: Approved for a maximum amount, draw as needed
- Variable rate: Rate changes with market conditions
- Draw period: 5-10 years to access funds
- Repayment period: 10-20 years to pay back
- Interest-only option: Often available during draw period
Two Phases of a HELOC
Draw period (years 1-10):
- Access funds anytime up to your limit
- Make interest-only payments (or principal + interest)
- Revolving—pay down and redraw
- Rate adjusts periodically
Repayment period (years 11-20):
- Can no longer draw funds
- Pay principal + interest
- Payment may increase significantly
- Some HELOCs allow refinance
Example HELOC
Jennifer has $120,000 in equity. She opens a $60,000 HELOC:
- Initial rate: 8.25% variable
- Draw period: 10 years
- Repayment period: 20 years
During draw period, she uses $35,000 for renovations. Her interest-only mortgage on $35,000 at 8.25% is $241/month. When repayment begins, she owes $35,000 plus accrued interest over 20 years.
Side-by-Side Comparison
| Feature | Home Equity Loan | HELOC |
|---|---|---|
| Disbursement | Lump sum | Draw as needed |
| Interest rate | Fixed | Variable (usually) |
| Monthly payment | Fixed | Varies |
| Access to funds | One-time | Ongoing during draw |
| Best for | Single large expense | Ongoing/variable needs |
| Rate (typical) | 8-10% | 7.5-9.5% |
| Closing costs | 2-5% | Often lower |
| Payment shock risk | None | Yes, at repayment |
When to Choose a Home Equity Loan
One-Time Large Expenses
Home renovation: You know the project costs $45,000. A lump sum covers it.
Debt consolidation: Pay off credit cards with one fixed payment.
Major purchase: Vehicle, boat or other significant expense.
You Want Payment Stability
Fixed payments make budgeting simple. You know exactly what you’ll pay for 10-20 years.
Rates Might Rise
If you expect rates to increase, locking in a fixed rate protects you from payment increases.
You Might Be Tempted to Overspend
A lump sum removes temptation. You can’t keep drawing like with a HELOC.
When to Choose a HELOC
Ongoing or Unpredictable Expenses
Home improvements over time: Multiple projects spread over years
Education costs: Tuition bills coming each semester
Business expenses: Variable needs as business grows
You Want Flexibility
Draw only what you need, when you need it. Pay interest only on what you’ve used.
Emergency Reserve
Keep a HELOC open as backup. Many people open them hoping to never use them—but they’re there if needed.
Lower Initial Costs
HELOCs often have lower closing costs than home equity loans. Some have zero closing costs.
Interest Rates Compared
Home Equity Loan Rates
Currently averaging 8-10% for well-qualified borrowers:
- Fixed for entire term
- Higher than HELOC initial rates
- Lower than credit cards and personal loans
HELOC Rates
Currently averaging 7.5-9.5%:
- Variable, tied to Prime Rate
- Prime is currently ~8.5%
- HELOC rate = Prime + margin (0.5-2%)
- Rate adjusts monthly or quarterly
Rate Movement Example
If Prime Rate increases 1%:
- Home equity loan: No change (fixed)
- HELOC: Rate increases 1%, payment increases
Angela’s HELOC started at 8% when Prime was 7.5%. When Prime rose to 8.5%, her rate jumped to 9%. On her $40,000 balance, monthly interest went from $267 to $300.
Requirements for Both
Equity Requirement
Most lenders require:
- 15-20% equity remaining after the loan
- Combined loan-to-value (CLTV) of 80-85%
CLTV calculation:
(First mortgage balance + New loan amount) ÷ Home value = CLTV
Example:
- Home value: $400,000
- First mortgage: $280,000
- New loan requested: $40,000
- CLTV: ($280,000 + $40,000) ÷ $400,000 = 80%
At 80% CLTV, this borrower qualifies.
Credit Score Requirements
| Score | Approval Odds | Rate Impact |
|---|---|---|
| 740+ | Excellent | Best rates |
| 700-739 | Good | Slightly higher |
| 660-699 | Fair | Moderate increase |
| 620-659 | Possible | Higher rates, limited options |
| Below 620 | Difficult | Very limited |
Income and DTI
Lenders verify:
- Stable employment (2+ years preferred)
- debt-to-income ratio under 43% typically
- Ability to handle new payment plus existing mortgage
Costs and Fees
Home Equity Loan Costs
| Fee | Typical Amount |
|---|---|
| Application fee | $0-$100 |
| Appraisal | $300-$500 |
| Origination fee | 0-1% |
| Title search | $150-$400 |
| Recording fees | $50-$150 |
| Total closing costs | 2-5% of loan |
On a $50,000 loan, expect $1,000-$2,500 in closing costs.
HELOC Costs
| Fee | Typical Amount |
|---|---|
| Application fee | $0-$50 |
| Appraisal | $0-$500 (often waived) |
| Annual fee | $0-$75 |
| Early termination fee | $300-$500 if closed within 2-3 years |
| Total upfront | Often $0-$500 |
Many lenders waive HELOC closing costs to attract customers.
Risks to Consider
Home Equity Loan Risks
Your home is collateral: Failure to pay could result in foreclosure.
Fixed amount: If you need more later, you’d need another loan.
Closing costs: Significant upfront expense.
HELOC Risks
Variable rate: Payments can increase substantially.
Payment shock: Transition from draw period to repayment can double payments.
Temptation: Easy access may encourage overspending.
Freezing: Lenders can freeze or reduce lines during economic downturns.
Payment Shock Example
Sarah has a $50,000 HELOC at 8%. During her draw period, she pays interest-only: $333/month.
When repayment begins (15-year amortization), her payment jumps to $478/month—a 44% increase.
If rates rise to 10% during repayment: $537/month—61% higher than her draw period payment.
Tax Considerations
Interest on both products may be tax-deductible if:
- Funds are used to “buy, build or substantially improve” the home
- You itemize deductions
- Total mortgage debt is under $750,000
Deductible: $40,000 HELOC used to remodel kitchen
Not deductible: $40,000 HELOC used to pay off credit cards or buy a car
Consult a tax professional for your specific situation.
Alternatives to Consider
Cash-Out Refinance
Replace your current mortgage with a larger one and pocket the difference.
Better when:
- Your current rate is higher than today’s rates
- You want one payment instead of two
- You’re borrowing a large amount
Personal Loan
Unsecured loan based on credit and income.
Better when:
- You don’t have much equity
- You need a smaller amount ($5,000-$50,000)
- You don’t want to risk your home
Credit Cards
For smaller, short-term needs.
Better when:
- Amount is small ($1,000-$5,000)
- You’ll pay off quickly
- You have a 0% intro APR offer
Frequently Asked Questions
Which has lower interest rates?
HELOCs typically have lower initial rates but are variable. Home equity loans have slightly higher rates but are fixed. Over time, a home equity loan may cost less if rates rise significantly.
Can I have both a home equity loan and HELOC?
Yes, as long as you have sufficient equity. Your combined loan-to-value including your first mortgage and both products must stay within lender limits (typically 80-85%).
How much can I borrow?
Most lenders allow borrowing up to 80-85% of your home’s value, minus your existing mortgage balance. On a $400,000 home with a $250,000 mortgage, you might access $70,000-$90,000.
Do I need an appraisal?
Usually yes for larger amounts. Some lenders use automated valuations for smaller loans or HELOCs, saving you $300-$500.
Can I pay off a HELOC early?
Yes, but check for early termination fees. Some lenders charge $300-$500 if you close the line within 2-3 years of opening.
What happens if my home value drops?
If your CLTV exceeds the lender’s limit, they may freeze your HELOC or prevent additional draws. You’d still owe what you’ve borrowed.
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David Thompson
Former Bank Underwriter, 20+ Years in Lending
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