If you’re a homeowner looking to access cash using your home’s value, you have two common options: a Home Equity Loan and a Home Equity Line of Credit (HELOC). Both let you borrow against the equity you’ve built in your property, but they function differently.
What is Home Equity?
Home equity is the difference between your home’s current market value and the amount you still owe on your mortgage.
Example:
If your home is worth $400,000 and you owe $250,000 on your mortgage, your equity is $150,000.
Lenders typically allow you to borrow up to 75% to 85% of your home’s appraised value (minus your outstanding mortgage balance).
1. Home Equity Loan
What is a Home Equity Loan?
A Home Equity Loan is a lump-sum loan that allows you to borrow a fixed amount of money, using your home as collateral. It functions like a second mortgage with a fixed interest rate and a set repayment term.
Key Features:
- Lump-sum payment: You receive all the funds at once.
- Fixed interest rate: Your interest rate and monthly payments remain the same over the life of the loan.
- Fixed term: Usually 5 to 30 years.
- Monthly payments: Include both principal and interest.
Best for:
- One-time major expenses (e.g., home renovation, medical bills, debt consolidation).
- Borrowers who want predictable payments.
2. Home Equity Line of Credit (HELOC)
What is a HELOC?
A HELOC is a revolving line of credit that lets you borrow money as needed, up to a certain limit, during a specified draw period. It works more like a credit card than a traditional loan.
Key Features:
- Credit limit: You can borrow up to a pre-approved amount.
- Variable interest rate: Rates can fluctuate based on market conditions.
- Draw period: Typically 5 to 10 years when you can borrow and repay repeatedly.
- Repayment period: Usually 10 to 20 years after the draw period ends—no new borrowing allowed.
- Flexible borrowing: You borrow only what you need, when you need it.
Best for:
- Ongoing or unpredictable expenses (e.g., college tuition, phased renovations).
- Borrowers who want flexible access to funds.
Home Equity Loan vs. HELOC: Key Differences
| Feature | Home Equity Loan | HELOC |
|---|---|---|
| Disbursement | One-time lump sum | Draw as needed |
| Interest Rate | Fixed | Variable |
| Monthly Payment | Fixed | Varies based on usage & rates |
| Use of Funds | Best for one-time needs | Best for ongoing needs |
| Collateral Required | Yes (your home) | Yes (your home) |
| Repayment Start | Immediately | Usually after draw period |
| Predictability | High | Moderate |
Pros and Cons
✅ Pros of Both:
- Lower interest rates than credit cards or personal loans.
- Possible tax deduction on interest (if used for home improvement; consult a tax advisor).
- Flexible borrowing options.
❌ Risks and Drawbacks:
- Your home is collateral—risk of foreclosure if you default.
- With a HELOC, rates can rise and increase your payments.
- Fees may include application, appraisal, and closing costs.
- Borrowing too much can reduce your home’s equity and financial safety net.
Common Uses
- Home renovations or repairs
- Debt consolidation
- Major medical expenses
- College tuition
- Emergency fund (HELOCs often serve this role due to flexibility)
How to Qualify
Lenders typically look at:
- Your home’s equity (usually 15% to 20% minimum)
- Credit score (typically 620+ for home equity loans, higher for HELOCs)
- Debt-to-income ratio (DTI)—generally should be under 43%
- Income and employment history
Tips Before You Borrow
- Understand the terms: Know your interest rate, repayment schedule, and any fees.
- Have a plan: Use the funds for value-building or essential purposes.
- Don’t overborrow: Just because you qualify doesn’t mean you should take the maximum.
- Watch for variable rates: With a HELOC, rising interest rates can increase your payments.
- Compare lenders: Shop around for the best terms and lowest fees.
Would you like a sample scenario or repayment comparison between a Home Equity Loan and a HELOC? I can provide a side-by-side example using dollar amounts. Let me know!