Home equity loan vs. line of credit? Here’s what you need to know
Both allow you to borrow against the appraised value of your home, providing you with cash when you need it. Here's what the terms mean and the differences between a home equity line and loan that can help you figure out whether they're the right fit for you. If you’ve built up equity in your home—if it’s worth more than the balance on your mortgage—you may be able to use part of that value to meet financial needs such as cash for home improvement projects, large expenses, education expenses or to pay for unexpected costs. Home equity lines of credit (HELOCs) and home equity loans (HELOANs) are two ways to achieve similar ends. But they are different, and understanding how each one works can help you decide whether one or the other might work for you.
What is a home equity line of credit?
A HELOC provides ongoing access to funds. Unlike a conventional loan a HELOC is a revolving line of credit, allowing you to borrow more than once. In that way, it's like a credit card, except with a HELOC, your home is used as collateral.
A HELOC has a credit limit and a specified borrowing period, which is typically 10 years. During that time, you can tap into your line of credit to withdraw money (up to your credit limit) when you need it. You use the funds only when you need to, and you can continue to use the funds as you repay them.
A HELOC can be opened to fund a specific need, or can be opened ahead of time so that access to funds is available when needed.
You only pay interest on the money you use.
Most HELOCs charge variable interest rates. Those rates are tied to a benchmark interest rate and can adjust up or down.
You may be able to convert some or all of the balance you owe on a variable-rate HELOC to a fixed-rate loan.
During the borrowing period, you'll need to make at least minimum monthly payments on the amount you owe, typically this payment includes portions of principal and interest.
Once the borrowing period ends, you’ll repay the remaining balance on your HELOC, with interest, just like a regular loan. The repayment period is usually 10 or 20 years.
What is a home equity loan?
A HELOAN resembles a traditional loan. You borrow a specific amount, which is provided as a one-time cash payout at closing, and then you make regular payments during a fixed repayment period.
With a home equity loan, you apply for the amount you need.
Most charge a fixed interest rate that doesn’t change during the life of the loan.
Each payment, the same every month (if it is a fixed-rate HELOAN), includes interest charges and a portion of the loan principal.
How can you use home equity?
Your home may be your most valuable asset, and borrowing against your equity in it could free up cash for any of several purposes. You might use the money to:
Fund projects, repairs, or pay for large purchases.
Consolidate what you owe on credit cards or other higher-rate debts into a single loan. Since your home is used as collateral for HELOCs and HELOANs, these loans typically have lower interest rates than other kinds of loans.
Cover emergency expenses. If you’ve used up the cash in your emergency fund, you could draw on a HELOC to pay for house repairs, medical bills or other unexpected costs.
Help pay for education tuition and fees. Home equity line or home equity loan interest rates may be lower than rates on college loans.
The flexibility of a HELOC can make it a great resource for managing cash flow, with quick access to funds and that can be repaid.
Is a home equity line or loan right for you?
Both loans can give access to funds for a specific need. If you know you only need a one-time lump sum of cash, then a HELOAN may be the way to go. It's key advantages are a conventional loan structure and a payment structure that is typically more predictable and easier to navigate. A HELOC gives you the same ability to access funds, with the added benefits of flexibility and readiness. Use it as a tool to finance home improvements or as a financial safety net that's there when you need it.
With either, the amount you can borrow will depend on the value of your home and the amount of equity you have available. And with both, it’s important to remember that you’re using your home as collateral—and it could be at risk if its value drops or there’s an interruption in your income.
But if you qualify and your financial situation is stable, a home equity line or a home equity loan could be a helpful, cost-effective tool for making the most of your home’s value.