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Home Equity Loans vs. HELOCs: Which One Should You Choose?
0:33 - What is home equity?
1:28 - What is a HELOC (home equity line of credit)?
2:26 - What is a home equity loan?
4:37 - Cash out refinance
There’s often confusion between home equity loans versus HELOCs -- or home equity lines of credit. Both let you tap your home equity for cash but they function quite differently.
Before we go into that, let's first talk about home equity.
Put simply, equity is the share of a home or property you actually own. To calculate how much equity you have, start with your home’s value and then subtract your remaining mortgage balance.
You can use the funds to pay for home renovations, medical bills, tuition costs, or any other expenses you might have coming your way. You can also use home equity products to consolidate and pay off higher-interest debts like credit cards and personal loans.
You can think of HELOCs a bit like a credit card, they act as a line of credit and you can use the money whenever you like. A HELOC can be an alternative to a credit card which could carry a double-digit annual percentage rate.
You can withdraw funds over an extended period of time called a draw period. This can last up to 10 years. During this time, you’ll typically make interest-only payments on only the amount of money you’ve taken out (not your full credit line).
After the draw period is up, you’ll enter the repayment period, in which you’ll start to repay the money you borrowed plus interest. This period usually lasts from 10 to 20 years.
HELOCs typically come with a variable interest rate, meaning the rate will fluctuate over time. You’ll usually get a low promotional rate at the beginning of the loan, and the rate will increase as you get into the repayment period.
A home equity loan is like a traditional mortgage loan in that you’re given a lump sum all at once, rather than a line of credit you can draw from at will.
Home equity loans act as second mortgages, meaning you’ll need to make two mortgage payments each month.
You then pay the balance back month over month across your loan term, which typically ranges from five to 30 years. Because home equity loans can give you access to large amounts of cash at once, they’re often a smart choice if you have a big expense you’re dealing with.
The biggest downside of using home equity products is that you are potentially putting your home at risk. Since home equity products use your property as collateral, you could find yourself in danger of foreclosure if you fall behind on payments.
There are also costs to consider. Home equity products come with closing costs and fees. On HELOCs, you might even see fees each time you make a withdrawal. These can add up over time, especially if you expect to make several transactions over time.
Choosing between home equity loans vs. HELOCs comes down to how much money you need, how predictable your expenses are, and your current financial limitations.
The first thing you’ll want to think about is what you intend to use the money for. Generally speaking, a home equity loan is going to be best if you have a large, predictable, one-time expense to cover, like a new roof, a major car repair, or consolidating other debts.
If your costs are less predictable or you expect them to recur over time (like tuition bills or medical treatments), a HELOC may be a better option, as it allows you to pull funds as needed across an extended period of time.
Next, think about your financial situation. How predictable is your income? Do you need consistent payments that you can easily budget for, or can you afford more fluctuation?
If you need consistency, a home equity loan is your best bet. These come with fixed interest rates and predictable payments for the entire loan term.
If you’re set on tapping your home equity, HELOCs and home equity loans aren’t your only option. You might also consider a cash-out refinance. This allows you to replace your existing mortgage loan balance with a new, larger loan. You then take the difference between the two in cash, which you can use toward home improvements or any other expense, just like HELOCs and home equity loans.
Use your home equity wisely
Tapping into your home equity is not a decision to be made lightly. You probably don't want to use your home equity to finance luxury items.
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