Chances are, your home is your biggest financial asset. As you pay down your mortgage, you build equity that you can put to work through a HELOC or home equity loan.
Both loans use your home as collateral, which can be a powerful motivator for timely repayments. But how you access your cash depends on the loan you choose.
What’s the difference between a line of credit and a home equity loan?
The main difference between a HELOC and a home equity loan is how you get your money. HELOCs offer you a pool of money to draw from whenever you need it, whereas you get all your money in one sum when you take out a home equity loan.
| Typical eligibility | - At least 15% equity in home
- Up to 50% debt-to-income ratio
- 620+; 720+ for the strongest rates
- Ability to repay based on income, assets, monthly expenses and credit history
| - At least 15% equity in home
- Up to 50% debt-to-income ratio
- 620 or higher credit score
- Ability to repay based on income, assets, monthly expenses and credit history
|
| Interest rate | Variable, though some lenders have fixed options | Fixed |
| Access to funds | Withdraw money as you need it, paying interest on the amount you draw | Lump-sum payment |
| Use of funds | Unrestricted | Unrestricted |
| Term lengths | 10-year draw period
20-year repayment period | Typically five to 30 years |
| Closing costs | Varies | Yes |
| Annual fee | Typically $50-$75 | No |
| Collateral | Home | Home |
How HELOCs work
A HELOC is a lot like a credit card. You’re given a set line of credit, which typically can be up to 80% of your home’s equity, and you can borrow against that amount as much as you need during a draw period, which is usually 10 years.
During that period, you make interest-only payments on the amount you draw. But a HELOC comes with a variable interest rate, causing your payments to fluctuate slightly as interest rates rise and fall with the market.
When the draw period ends, your HELOC payments are amortized to include principal and to ensure you can pay off the entirety of what you borrowed within the repayment period.
Fixed-rate HELOC options
Some lenders allow you to convert set amounts of your HELOC into fixed-rate accounts during the draw period, usually amounts of $5,000 or more. Once converted, that amount is no longer available to the credit line, and you make payments on the new account like a loan until it’s paid off.
Depending on the lender, you may also be able to set your own term for that new account, as long as the term doesn’t exceed the repayment term of the HELOC. If you pay it off while the draw period is still active, you may be able to convert the amount back to the credit line for a fee.
For example, if my HELOC credit line is $50,000, and I’ve spent $10,000, I can convert that $10,000 into a fixed-rate account and set the term to five years. That means my credit line is now $40,000, and I have to make amortized payments on the $10,000 until it’s paid off while still making interest-only payments on whatever I draw from the HELOC during that time. At the end of the term, I can choose whether to convert that amount back into a HELOC amount or not.
Pros
- Only pay interest on your account balance
- Lower interest rates
- No closing costs
- May be able to write off the interest on your taxes
Cons
- Variable interest may rise during your draw period
- Annual fee
- Leveraging your home against what is essentially a high-limit credit card
How home equity loans work
A home equity loan is sometimes called a second mortgage, and like a mortgage, you get the money in a lump sum to use at your discretion. A home equity loan has a fixed interest rate and repayment schedule, so you’ll have the same monthly payments for the life of the loan, but your rate will most likely be higher than what you could get at an adjustable rate.
As a mortgage, most home equity loans require you to qualify and pay between 2% and 5% in closing costs. You’ll also need to repay your existing mortgage while also making your home equity loan payments.
Pros
- Fixed interest rate
- Predictable payments
- May be able to write off the interest on your taxes
Cons
- Closing costs
- Higher interest rate than a HELOC
- Two mortgage payments every month
When a HELOC is a better choice
You may want to choose a HELOC if you:
- Expect your expenses to increase over time.
- Want flexible access to your money.
- Need credit approval quickly.
When a home equity loan is a better choice
Choose a home equity loan if you:
- Need money for a one-time expense.
- Want predictable payments with fixed interest rates.
- Have at least 15% equity in your home and a credit score of at least 620.
Which is faster?
There’s no significant difference in how quickly you can get a HELOC or home equity loan. Approvals on both can take between two to six weeks, on average, depending on the lender and how quickly you submit the required documentation.
There are lenders who advertise quick turnaround times, such as a five-day approval. But that kind of timeline depends on many factors, such as whether your state allows e-signature notary, whether your county requires in-person closing and what kind of property appraisal your lender requires.
Get an estimated timeline from your lender before you apply.
Tax deductions for HELOC vs. home equity loans.
The IRS treats all home equity products the same when it comes to tax deductions. And you may be able to write off the interest on your HELOC or home equity loan — as long as it meets the following rules:
- The total borrowed between your mortgage and home equity product can’t exceed $750,000.
- The money must be used to purchase a second home, build onto your home, or “substantially improve” your home.
The home improvements need to be more substantial than paint or wallpaper to qualify for the deduction. And if you use the money to pay off debt or pay for something outside of your home, you won’t be able to write off the interest at all.
If your total borrowed exceeds the limit, you may still be able to write off a portion of your interest. And there are other special circumstances surrounding whether you use the home as a rental or for a business, so make sure to consult a tax professional.
How to qualify
The requirements to qualify for a HELOC or home equity loan will vary by lender but aren’t much different between products. Both products share the following requirements:
- Sufficient equity in the property
- At least 620 credit score
- A debt-to-income ratio (DTI) of 50% or lower, but 43% is preferred
- Ability to repay based on income, assets, monthly expenses and credit history
- Proof of residency
Where they may differ is in how much of your equity you can access. For example, a HELOC can go as high as 85% to 90%, whereas a home equity loan typically allows you to borrow up to 80% LTV.
Can I have both at the same time?
You can have as many loans and lines of credit as your home’s equity allows. Most lenders won’t let you borrow much more than 80% of the equity in your home. And if you borrow up to that limit with one loan, you won’t be able to take out a line of credit or secondary loan.
More importantly, each additional loan or HELOC comes with closing costs and fees. A better option might be to find a HELOC that allows you to convert set amounts to fixed-rate loan accounts, allowing you to have the benefits of both without the fees of taking out loans separately.
Compare interest rates for home equity loans and HELOCs
Use our tool to get personalized estimated rates from top lenders based on your location and financial details. Select whether you’re looking for a Home Equity Loan, or a HELOC. Enter your ZIP code, credit score and information about your current home to see your personalized rates.
Alternatives to HELOCs and home equity loans
If neither a HELOC or home equity loan seems right for you, there are still a couple of ways to tap into your equity.
- Reverse mortgage. If you’re over 62 and own your home outright, you may qualify for a reverse mortgage, which supplements your retirement income with payments from your home’s equity. The loan repayment is due in full when you die or on the sale of the house.
- Cash-out refinance. Refinance your mortgage for more than you owe and take the difference as a lump sum of cash. A cash-out refinance typically allows you to borrow up to 80% of your home’s value.
Bottom line
If you need cash, you may be able to use your home as collateral with a home equity loan or line of credit. HELOCs give you flexible access to your money over time and can help you ensure you don’t take out more than you need, while home equity loans are best for financing a project with a fixed cost.
