Home Equity Lines vs Home Equity Loans: Which is Better for You?

As a homeowner, your house is likely one of your biggest assets. The equity you’ve built up in your home over time gives you options when you need to access cash. Two common ways to leverage home equity are home equity lines of credit (HELOCs) and home equity loans. But what’s the difference, and which one is right for your needs?

I’ll compare HELOCs and home equity loans in this article to help you understand the key features and determine which type of home equity financing may be a better fit based on your situation

What is Home Equity?

Before diving into the specifics of HELOCs and home equity loans, let’s quickly review what home equity is.

Home equity represents your ownership stake in your home. It’s calculated by taking the current market value of your home and subtracting any debts secured against it like your mortgage balance.

For example, if your home is worth $300,000 and you owe $150,000 on your mortgage, your home equity is $150,000. This is the amount you could access through a HELOC or home equity loan.

HELOC Overview

A home equity line of credit (HELOC) uses your home as collateral to provide revolving access to cash. It works similarly to a credit card.

Here are some key features of HELOCs:

• Revolving credit: You can repeatedly draw money, repay it, and redraw up to your credit limit.

• Draw period: Typically 10 years where you can access funds.

• Variable interest rate: The interest rate fluctuates based on an index like the prime rate. Rates are often prime + a margin of around 2%.

• Interest-only payments: During the draw period, you only need to pay interest on the amount borrowed.

• Repayment period: After the draw period, you enter repayment where you must pay down the balance over 5-20 years.

Pros

• Flexibility in when and how much you borrow
• Lower monthly payments during draw period
• Ability to reborrow repaid amounts

Cons

• Variable rates may increase over time
• Discipline required to avoid ballooning debt
• Temporary access to funds

Home Equity Loan Overview

Home equity loans provide homeowners with a lump sum of cash that is repaid over a fixed term with a fixed interest rate.

Key features of home equity loans:

• Fixed amount: You receive funds in a lump sum at closing.

• Fixed rate and term: Interest rate and repayment timeline don’t change.

• Principal and interest payments: Monthly payments include both principal and interest.

• Single repayment term: Typically 5-30 years without the option to reborrow funds.

Pros

• Predictable monthly payments
• Fixed interest rate
• May have longer repayment term than HELOC

Cons

• Less flexible than HELOC
• Pay interest on full amount borrowed immediately
• Can’t reborrow repaid amounts

Which Option is Better?

There’s no definitiv right or wrong option here – it depends on your specific needs and financial situation.

Here are some key considerations as you decide between a HELOC or home equity loan:

How much money do you need?

HELOC: Better if you need various sums of cash over time.

Home equity loan: Better if you need one large lump sum all at once.

When will you use the funds?

HELOC: Allows you to access cash as needed over a draw period.

Home equity loan: Provides the full amount upfront in a single disbursement.

What will you use the money for?

HELOC: Good for ongoing expenses or projects paid incrementally over time.

Home equity loan: Works for large one-time expenses like home renovations.

What are your repayment plans?

HELOC: Allows interest-only payments and reborrowing flexibility during the draw period.

Home equity loan: Works best if you’re able to start repaying principal right away.

Do you prefer fixed or variable rates?

HELOC: Has a variable rate that fluctuates based on an index.

Home equity loan: Offers fixed interest rates for the full repayment term.

Compare Interest Rates

Interest rates are another key difference.

HELOC rates are variable and tied to an index rate like prime. Initial rates often start around prime + 2%.

Home equity loans have fixed interest rates, often ranging from 3.5% to 5.5% for well-qualified borrowers.

The stability of fixed rates is appealing to many homeowners. However, if you have a HELOC, you may have the option to convert to a fixed rate later on.

How Much Can You Borrow?

The amount you can borrow depends on factors like:

• The equity in your home
• Your income, credit score and debt-to-income ratio
• Which lender you use

Lenders often approve borrowing up to 85% of your home equity for a HELOC or home equity loan.

For example, if your home is worth $400,000 and your mortgage balance is $200,000, then your home equity is $200,000. So you may be able to borrow around $170,000 with a HELOC or home equity loan.

Some lenders may allow you to borrow up to 90% or more of your home’s value minus your mortgage balance.

Closing Costs

You’ll pay closing costs for both HELOCs and home equity loans when you first open the account or loan. Closing costs may include:

• Origination fees
• Appraisal fees
• Attorney fees
• Recording fees
• Title insurance

Closing costs typically range from 2-5% of the total loan or credit limit. So make sure to factor this into your planning.

The Bottom Line

HELOCs provide flexible revolving access to home equity, while home equity loans offer fixed loan amounts and predictable repayment. Consider your specific needs and financial situation as you determine which option may be a better fit.

Be sure to shop around with multiple lenders to compare interest rates and fees. And consult a financial advisor if you need help evaluating home equity financing options. Leveraging home equity can provide affordable access to funds – if used wisely.