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HELOAN vs. HELOC: A Guide to the Key Differences
Key takeaways
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HELOANs and HELOCs both let you borrow against home equity. Because your home secures the debt, interest rates may be more favorable
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A HELOAN pays out one lump sum with a fixed rate and fixed monthly payments, making budgeting easier for one-time, planned costs
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A HELOC is a revolving line of credit you draw from as needed, usually with a variable rate. It affords greater flexibility for unexpected costs
When it comes to tapping the equity you've built up in your home to address a financial need, there are two main home equity borrowing options: a home equity loan (HELOAN) and a home equity line of credit (HELOC).
Though both types of loans give you access to your home's equity—which is the market value of your home minus what you owe on a mortgage—there are big differences in their features and benefits.
It's also important to understand that, for either type of loan, your home is the collateral. While that can help to keep interest rates down, borrowers risk foreclosure if they can't make the payments.
In this article, we'll explain the differences between a home equity loan vs. a HELOC, the pros and cons of each, and what to consider when you're deciding which is right for you
What is a home equity loan (HELOAN)?
A home equity loan (HELOAN) is a fixed-rate loan that allows you to borrow against home equity. They are sometimes referred to as second mortgages.
A HELOAN provides a lump sum of money upfront, which you repay over a fixed term at a fixed interest rate with fixed monthly payments, just like your mortgage.
What are the key features of a HELOAN?
Here's how home equity loans work.
You qualify by having the minimum equity required, usually 15% to 20%, depending on the lender. The lender determines your creditworthiness by looking at your credit profile and credit score and determining whether you meet debt-to-income guidelines.
There may be closing costs for home equity loans, and the lender may also require an appraisal of your property.
Features of a home equity loan include:
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One-time disbursement of funds. Once you receive the money, there's no access to additional funds
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Fixed interest rate. Like most mortgages, the interest rate on home equity loans stays the same for the life of the loan
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Predictable monthly payments. HELOAN monthly payments are the same every month, making automatic payment and budgeting easier
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Fixed repayment term. HELOAN terms can range from 5 years to 30 years
A HELOAN is best for ...
Home equity loans are good for covering financial needs for which you already know the budget. Examples include:
- A one-time expense, such as starting a business
- Unsecured debt consolidation. With the lower interest rate possible with a home equity loan, you may be able to consolidate high-interest rate debt
- A home renovation, upgrade, addition, or repair
- An unexpected medical bill or other emergency expense
A major purchase, such as a wedding. However, HELOANS are not recommended for vacations, cars, or daily expenses
What is a home equity line of credit (HELOC)?
A HELOC is a revolving credit line that works similarly to a credit card. You can borrow, repay the principal, and borrow it again up to your approved limit during the draw period.
The draw period can range from 5 to 15 years, during which you might make interest-only HELOC payments. During the repayment period, you start repaying the principal as well, usually over an additional 20 years.
HELOCs typically come with checks and/or a debit card, making it easy to access funds.
What are the key features of a HELOC?
Here's how a home equity line of credit works:
As with HELOANs, you must have 15% to 20% equity and meet debt-to-income guidelines. The lender may require an appraisal, and there may be closing costs.
Features of a home equity line of credit include:
- A revolving credit line. As you pay back some of the principal, you can borrow it again, as with a credit card
- Variable interest rates. The interest rates on HELOCs typically fluctuate with the prime rate or a similar benchmark rate. Payments may differ from month to month
- Borrow as needed. You can borrow as little or as much as you need, up to the credit limit, and you pay interest only on what you borrow
- Interest-only payments during the draw period. HELOC interest-only payments keep monthly payments lower initially. You might have the option of paying down the principal at the same time, which could reduce the size of payments after the draw period
- Repayment period includes principal plus interest. Payments during the HELOC repayment period could suddenly get bigger because you're paying back principal as well
A HELOC is best for ...
A home equity line of credit provides a flexible source of funds to cover expenses as they arise. You can keep a HELOC in your back pocket and use it when:
- Paying unpredictable expenses
- Financing a phased home improvement project
- Consolidating unsecured debt, as from a credit card, at a lower interest rate
- Covering emergency expenses, such as a car repair or a new roof
HELOAN vs. HELOC: Key differences
Let's summarize differences one typically finds between a HELOC vs. a home equity loan.
1. Payout
HELOAN: One-time disbursement of funds in a lump sum.
HELOC: Access to funds as needed, similar to a credit card.
2. Interest
HELOAN: Fixed rate that lasts for the life of the loan.
HELOC: Variable rate that may rise or fall over time.
3. Repayment
HELOAN: Fixed payments for the entire term.
HELOC: Interest-only payments during draw period; principal plus interest or a balloon payment during repayment period.
4. Ideal uses
HELOAN: Best for one-time, planned expenses.
HELOC: Best for ongoing or flexible spending needs.
5. Predictability
HELOAN: Predictable payments and long-term stability no matter what happens with market rates.
HELOC: Payments may fluctuate based on market rate changes.
6. Flexibility
HELOAN: No access to additional funds after receiving a lump sum.
HELOC: Borrow, repay, and borrow again as needed.
|
HELOAN |
HELOC |
|
|---|---|---|
|
Payout Interest rates Repayment Ideal uses Predictability Flexibility |
One-time disbursement of funds in a lump sum Fixed rate that lasts for the life of the loan Fixed payments for the entire term Best for one-time, planned expenses Predictable payments and long-term stability regardless of market rates No access to additional funds after receiving a lump sum |
Access to funds as needed, similar to a credit card Variable rate that may rise or fall over time Interest-only payments during draw period; principal plus interest or a balloon payment during repayment period Best for ongoing or flexible spending needs Payments may fluctuate based on market rate changes Borrow, repay, and borrow again as needed |
Pros and cons of a HELOAN
As we've noted, the pros of a HELOAN include:
- Predictable fixed payments
- Stable interest rate
- Ideal for large, defined expenses
- Easier budgeting
But you also have to consider other aspects, such as:
- Less flexibility. If you need more funds, you'd have to apply for an additional loan
- Interest accrues on the entire amount. If your $20,000 home project ends up costing $15,000, you still pay interest on the whole loan
- May have higher monthly payments initially. With a HELOAN, you start paying back the principal immediately
Pros and cons of a HELOC
HELOCs also have their positive points, as we've noted:
- Flexible access to funds during the draw period
- Borrow only what you need
- Pay interest only on what you borrow
- Lower interest-only payments during the draw period
You must also be aware of other points, including:
- Variable interest rates. Higher rates could lead to larger monthly payments
- Repayment phase may create “payment shock.” After the draw period, when payments on the principal kick in, you could be overwhelmed by the higher monthly payments. Some HELOCs have a balloon payment at the end of the draw period
- Temptation to overspend. Because of low initial payments and easy accessibility to funds, some borrowers take on more debt than they can handle
- Potential fees. Lenders may assess an annual fee, a fee for lack of activity, a fee for terminating the HELOC early, or a conversion fee for switching the balance to a fixed rate. The lender might also require a minimum draw
- Your home serves as collateral. Because the loan is secured by your house, you could lose it if you're unable to make your payments. This applies to a HELOAN, too
How do I choose between a HELOAN and HELOC?
Wondering whether a home equity loan or home equity line of credit is appropriate for your needs? Here are some considerations.
1. Do you need a lump sum or flexible access?
If you need a certain sum for a particular project, HELOAN.
If you need flexible access to funds, HELOC.
2. Are predictable payments important to you?
If you want to be sure of what you'll pay each month, HELOAN.
If you are able to tolerate potentially different payments, HELOC.
3. What are you using the funds for?
A project or financial need with an established budget, HELOAN.
An ongoing project whose final cost is uncertain, HELOC.
4. What is your comfort level with variable interest rates?
If you want to be protected from higher interest rates, HELOAN.
If you'd rather benefit in case rates fall, HELOC.
FAQs
There are several. A home equity loan provides a one-time disbursement, while a home equity line of credit is more like a credit card, with ongoing access to funds over a draw period.
A HELOAN features fixed interest, fixed monthly payments, and a fixed repayment period. Most HELOCs have variable interest rates and two components: a draw period and a repayment period. Monthly payments may fluctuate.
With a home equity loan, you begin repaying principal with interest immediately. A HELOC may defer payments on the principal until the repayment period, when your monthly payments could increase sharply.
Whether a lump sum vs. revolving line of credit is better depends on how you intend to use the funds. A HELOC is better for flexible, ongoing borrowing, such as for a remodeling project. A HELOAN is better for one-time expenses with an established budget.
Yes, as long as you meet credit requirements, have sufficient equity in your property, and can afford the monthly payments. Missing payments on either one could result in foreclosure.
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