Tapping into your home’s equity can provide a practical financing option that’s only available to homeowners. A home equity loan and a home equity line of credit (HELOC) allow homeowners to borrow from their available home equity without having to refinance their mortgage. In this blog, we will discuss the differences between HELOCs and home equity loans so you can discover which one best fit your needs.
What is the Difference Between a HELOC and a Home Equity Loan?
When deciding between a home equity loan and a HELOC, you’ll need to first understand the differences between them. A home equity loan provides a lump sum of money with a fixed repayment structure, while a HELOC provides a line of credit that you can draw from during a set draw period.
Both are secured by the borrower’s home and are considered second mortgages if you have a first mortgage. The amount you can borrow depends on your available equity and lender requirements. When comparing HELOC versus home equity loans, there are differences and similarities.
| |
Home Equity Loan |
HELOC |
| Access to funds |
Receive the loan as a one-time lump sum |
Receive a revolving line of credit that you use as needed |
| Rate structure |
Has a fixed interest rate so repayment can be more predictable |
Has a variable rate that may allow you to borrow at a lower rate than credit cards |
| Common use cases |
Debt consolidation, major projects such as pool installation or kitchen remodel, or major expenses such as weddings and medical bills |
Educational expenses such as tuition over multiple years, phased home remodels or emergency financial backup |
How Does a Home Equity Loan Work?
A home equity loan is a lump sum loan that the borrower must repay over a set term. It is a fixed-rate loan with a fixed monthly payment, which makes budgeting more predictable. The amount accessible for the loan depends on the home’s available equity and other requirements determined by the lender.
Homeowners may use a home equity loan for several purposes, including:
- Home improvements and remodels
- Debt consolidation
- Emergency expenses
- Education expenses
- Major one-time purchases
How Does a HELOC Work?
A HELOC is a line of credit secured by the home’s equity that allows borrowers to access funds as needed during a draw period, typically 10 years, followed by a repayment period. HELOCs have a variable interest rate based on the market rate. During the draw period, you can make interest-only payments, pay a portion of the amount borrowed plus interest or pay the amount in full. Be sure to check your lender’s disclosures for more information about your loan and repayment terms.
Here are a few of the common things to know about a HELOC:
- Outstanding balance: As the amount you borrow increases, the minimum payments increase. If you pay more than the minimum during the draw period, the principal amount decreases.
- Rate structure: HELOCs have a variable interest rate that fluctuates based on the market. If the rate increases, your payment can also increase.
- Repayment stages:
- Draw period: During this period, you can borrow, repay and reborrow funds up to your credit limit. Required payments during this period are interest only, which keeps the monthly bills low.
- Repayment period: During the repayment period, the credit limit closes and all borrowing stops. Any remaining balance is restructured into an amortized payment that you must repay in monthly payments made up of the principal and the interest.
HELOC vs. Home Equity Loan: Which Offers More Predictable Payments?
When deciding if a HELOC or a home equity loan is right for you, evaluate the payment structures and see which aligns with your financial picture. Home equity loans are generally easier to budget because of the fixed payments, which lets you plan confidently.
Payments for HELOCs vary depending on the outstanding balance, the rate structure and whether the HELOC is in the draw or repayment period. This makes them less predictable than home equity loans. HELOCs, however, allow greater flexibility because you only borrow what you need at that moment instead of receiving a lump sum amount.
Which Option May Be Better for Home Improvement Projects?
Both types of loans are great for home improvement projects. Exactly which to choose depends on the timing of those projects. A home equity loan may fit a project with known upfront costs because the loan is given as a lump sum amount. These types of projects include roof replacement, garage door installation or interior or exterior painting.
A HELOC may fit a project with expenses that occur in stages or are harder to predict. These examples include a whole kitchen remodel, flooring in several rooms or a backyard makeover. When deciding which type of loan to choose, compare total borrowing needs, the project timeline, the project budget and the repayment comfort level.
What Should You Compare Before Choosing a HELOC or Home Equity Loan?
There are several things to compare between a HELOC and a home equity loan. Among them are:
- Interest rate or APR
- Loan term
- Fixed versus variable rate structure
- Lender fees and requirements
- Draw period and repayment period
- Monthly payment expectations
- Total borrowing need
When choosing your home equity product, the lowest rate should not be the only factor in your decision. Keep in mind the product’s structure as well as the repayment terms. Also, review all disclosures so you fully understand the loan requirements.
How Much Home Equity May You Need to Borrow?
Before tapping into your home equity, determine how much you’ll need to borrow and how much equity you have in your home. Your home equity is the difference between the property’s current value minus the amount owed on the mortgage. The amount you can borrow depends on the available equity, credit and income qualifications set by the lender.
For example, to determine the available equity if you plan to open a home equity loan, use this simple calculation to determine available equity:
- If your remaining mortgage balance is $200,000 and your current home’s value is $500,000, then your available equity is $300,000
What Are the Risks of Borrowing Against Your Home?
No matter the type of home equity loan, it is important to consider the risks involved. Both HELOCs and home equity loans are secured by the borrower’s property, so on-time repayment obligations must be met. If you use a HELOC, the variable rate can make future payments less predictable and increase repayment risk.
Remember that there is always a degree of risk with any borrowing, so consider loans that fit your current budget, especially when using your home as collateral.
When Might a Home Equity Loan Make More Sense Than a HELOC?
A home equity loan might make more sense than a HELOC if you know exactly how much you need to borrow and are certain there won’t be additional expenses. Even so, it’s good practice to compare a home equity loan and a HELOC.
When Might a HELOC Make More Sense Than a Home Equity Loan?
A HELOC might make more sense if you’re planning a multi-stage project with ongoing expenses and different contractors who you’ll need to pay. It is also better if you want to have access to funds for future expenses but don’t want to borrow now. A HELOC’s revolving line of credit gives you flexibility to borrow as needed during the draw period.
How Travis Credit Union Can Help
TCU is a great resource for California homeowners who want to use their available equity to fund a home improvement project or another major expense. TCU offers both types of loans, as well as energy-efficient loans, to help improve your home.
Explore Travis Credit Union’s home equity loan and home equity line of credit options to compare how each works, review current terms and decide which borrowing structure may fit your financial goals. Get started at TCU’s Home Equity Loans Hub.
Frequently Asked Questions
What is the main difference between a HELOC and a home equity loan?
A home equity loan provides a one-time lump sum with fixed monthly payments over a set term. A HELOC offers a revolving line of credit that you can draw from as needed during the draw period.
Which option typically offers more predictable monthly payments?
A home equity loan generally offers more predictable payments because it usually has a fixed interest rate and repayment schedule. A HELOC's payment amount can change based on your balance, interest rate and repayment stage.
How do I decide whether a HELOC or home equity loan is right for me?
Consider how much money you need, when you'll need it and how comfortable you are with payment fluctuations. Projects with known costs may fit a home equity loan, while ongoing expenses may be better suited for a HELOC.
Can I use a HELOC or home equity loan for purposes other than home improvements?
Yes, many homeowners use these products for debt consolidation, education expenses, emergency costs or other major purchases. The funds can often be used for a variety of financial needs, subject to lender requirements.
How does a HELOC draw period work?
During the draw period, you can borrow, repay and reborrow up to your approved credit limit. This flexibility allows you to access funds only when needed rather than taking the full amount at once.
What happens when a HELOC draw period ends?
Once the draw period ends, you can no longer access additional funds from the line of credit. Any remaining balance enters the repayment period, during which principal and interest payments are required.
What factors determine how much I can borrow?
The amount available depends on your home's equity, your credit profile, income qualifications and other lender requirements. Lenders review these factors to determine your borrowing limit.
What should I compare before choosing a home equity product?
Review the interest rate, APR, loan term, fees, payment structure and repayment requirements. Understanding these details can help you choose the option that best fits your financial goals.
What are the risks of borrowing against my home's equity?
Both HELOCs and home equity loans use your home as collateral, which means repayment obligations are important. Borrowing more than you can comfortably afford may create financial strain if your circumstances change.
Can a HELOC be used as an emergency financial backup?
Many homeowners open a HELOC to have access to funds for unexpected expenses. Because you only borrow when needed, it can provide added financial flexibility during emergencies.
Do I need to refinance my mortgage to access my home's equity?
No, a home equity loan or HELOC allows you to tap into your available equity without refinancing your existing mortgage. This may help you keep your current mortgage rate if it is favorable.
Can I have both a mortgage and a HELOC at the same time?
Yes, many homeowners have a mortgage and a HELOC simultaneously. The HELOC is typically secured by the same property and functions as a second lien behind the primary mortgage.