HELOC vs. Home Equity Loan: Tailor Your Choice to Financial Goals

A home equity line of credit (HELOC) lets you draw on a credit line multiple times, up to a certain limit, while a home equity loan lets you borrow a single lump sum. A HELOC may be better suited for ongoing expenses, such as college tuition or a large renovation project, while a home equity loan may be better for one-time costs. 

There are several nuances to consider when looking at a HELOC vs. a home equity loan. Find out the details on how each one works, the pros and cons of both, and how to compare your options. 

Table of Contents

1. How does a home equity loan vs. a HELOC work? 
2. Pros and cons of a home equity loan 
3. Pros and cons of a home equity line of credit 
4. Home equity loan vs. line of credit: Which is better? 

How does a home equity loan vs. a HELOC work? 

Home equity loans and home equity lines of credit (HELOCs) both use your home equity as collateral for financing. As a homeowner, you may be able to borrow 85% of your home equity, assuming your income and credit are strong enough for the estimated payments. 

Home equity-based financing means lower interest rates than other financing alternatives, such as credit cards or personal loans. But a HELOC and a home equity loan can put your house at risk of foreclosure if you fall behind on your payments.

Beyond those similarities, the structure and repayment process vary for home equity loans and HELOCs.

How a home equity loan works

A home equity loan is an installment loan, which means you’ll repay your balance with fixed monthly payments over a certain period. Interest rates are usually fixed, and so is the amount you borrow. These firm numbers can make it easy to plan your budget. 

Payments are spread out over five to 30 years, which could keep your payments quite low.  The downside is that you’ll be in debt longer with an extended repayment period. 

Like a mortgage, a home equity loan usually comes with closing costs paid to the lender. The range is 2% to 5%. For example, based on those percentages, closing costs for a $50,000 home equity loan could total $1,000 to $2,500, due at closing. 

How a HELOC works

A HELOC is a form of revolving credit that allows you to draw on your credit line on your own schedule. Most lenders provide a checkbook or credit card attached to the account. The interest rate is often variable, but only your outstanding balance is charged. 

HELOCs are divided into two stages: the draw period, which typically lasts for 10 years, followed by a repayment period that lasts another 10 to 20 years. Depending on your lender, you may be able to convert your variable rate to a fixed rate during repayment, which can help keep monthly payments more predictable. 

While each lender has its own borrower criteria, most home equity loan and HELOC requirements include the following:

• Minimum credit score: Usually between 620 and 640
• Income and debt-to-income ratio (DTI): Helps determine affordability for your monthly payments based on other debt responsibilities; maximum DTI might be around 50%
• Equity: Many lenders require your loan-to-value ratio (LTV) to be at least 15%

Pros and cons of a home equity loan 

Here are the pros and cons to consider with a home equity loan compared to a HELOC.

Pros

• Fixed interest rate

  Home equity loan rates are usually fixed, so even if rates rise in the future, your payments will remain the same.

• Predictable payoff period

  Set monthly payments make it easy to budget for your home equity loan, which can give you more confidence in its affordability over the long term. 

• Longer repayment term

  Repayment terms might last as long as 30 years, which can keep your monthly bill low. 

Cons

• Must borrow a lump sum

  Unlike a HELOC, home equity loans aren’t set up to let you borrow more cash in the future without submitting a new loan application.

• Closing costs could be higher than a HELOC 

  You could pay as much as 5% of the loan amount at closing, which might add thousands of dollars to the total cost of the loan. 

Pros and cons of a home equity line of credit 

HELOCs also have pros and cons compared to a home equity loan. 

Pros

• Flexible funding amounts

  Instead of being limited to a one-time amount as you are with a home equity loan, a HELOC allows you to draw up to your credit limit over time. A typical draw period of 10 years can provide a long-term financial cushion.

• Interest only charged on the balance

  Interest only accrues on your outstanding HELOC balance. As you pay off your balance, your credit line replenishes in case you want to borrow more in the future. 

• Lower or no closing costs 

  Some HELOCs don’t have closing costs, unlike home equity loans. This can save you upfront cash.

Cons

• Payments could increase

  Because most HELOCs have variable interest rates, it can be hard to know what to expect to pay for your future payments. 

• Could overspend

  Access to a credit line could tempt you to draw funds for non-emergency or unplanned expenses. It’s smart to have a specific strategy for using your HELOC instead of taking withdrawals on a whim.

• May pay fees

  Some HELOCs charge various fees, including an annual fee to maintain the account, an inactivity fee if you don’t use your account, a cancellation fee if you close your account early, and a conversion fee if you transfer your balance from a variable to a fixed rate.

Do both options sound attractive? It’s also possible to have both a home equity loan and a HELOC at the same time if you meet the eligibility requirements. 

Home equity loan vs. line of credit: Which is better? 

Home equity loans and HELOCs are structured differently, so the right choice depends on how you plan to use the funds. Here’s a quick overview of when to choose a home equity loan or HELOC, plus more considerations below. 

Choose a home equity loan if…	Choose a HELOC if…
You have a large one-time expense	You have an ongoing expense or don’t know how much money you need
You’re prone to drawing more than you need	You’re confident in how you plan to withdraw funds
You want a set monthly payment	You have flexibility in your repayment budget

Typically, if the amount is a one-time large expense that they know they need, I recommend that my clients first shop around for the best terms for a home equity loan. 

However, due to the higher interest rates we have been experiencing, clients want to avoid locking in a fixed rate and instead choose to shop for a favorable HELOC with a variable rate that meets their funding goals. 

Ultimately, it depends on the amount they need, the interest rate environment, the housing market, and their risk tolerance.

Erin Kinkade, CFP®

When to choose a home equity loan

• Best for a one-time expense: Examples may include major life events, such as a wedding or adoption, or a small renovation with just one or two contractor payments.
• Best for sticking to a budget: A home equity loan doesn’t offer the temptation of drawing additional funds because you only have access to a one-time payment. If you’re unsure how easy it would be to manage a HELOC, this could be a better choice.
• Best for fixed payments: It’s easier to plan your payoff with a home equity loan because you have a clear timeline and monthly payment. If you’re comfortable with those numbers, you can feel confident about staying on top of your payments each month. 

When to choose a HELOC

• Best for ongoing or unknown expenses: A HELOC is well-suited for major renovations with multiple phases or tuition payments spread out over several years. 
• Best for confident budgeters: If you know how you’ll use your HELOC and that you’ll stick to it, having a credit line at your fingertips can be an appropriate choice.
• Best for flexible budgets: It’s difficult to calculate your exact HELOC repayment amount because variable interest and your outstanding balance can change over time. A HELOC may be better for individuals with flexibility in how much they can pay.

Recap: HELOC vs. home equity loan 

Detail	HELOC	Home equity loan
Rates	Variable	Fixed
Amounts	Percentage of your equity	Percentage of your equity
Draw period?	10 years	None
Repayment terms	10 – 20 years	5 – 30 years
Best for	Ongoing expenses	One-time costs