HELOC vs. Home Equity Loan: Key Differences for Homeowners

Understanding Home Equity Borrowing Options

Homeowners seeking to tap into their property’s value face a choice between a home equity loan and a home equity line of credit, known as a HELOC. Both options allow borrowing against the equity built up in a home, calculated as the current market value minus the outstanding mortgage balance. As of early April, with home prices stabilizing after years of growth, the average U.S. homeowner holds about $315,000 in equity, making these financial tools appealing for funding major expenses. Each option offers distinct features, from payment structures to interest rates, tailored to different financial needs.

Home Equity Loan Basics

A home equity loan provides a lump sum paid out at closing, repaid over a fixed term—typically 5 to 30 years—with a consistent interest rate. Lenders generally allow borrowing up to 85 percent of a home’s equity, requiring at least 15 to 20 percent equity remaining, a credit score of 680 or higher, and proof of steady income. For example, on a $400,000 home with a $200,000 mortgage, a homeowner might secure a $140,000 loan at 8 percent interest, locking in a predictable monthly payment of about $1,056 for 15 years. Closing costs, ranging from 2 to 5 percent of the loan amount, add $2,800 to $7,000 upfront.

HELOC Features and Flexibility

A HELOC, by contrast, operates as a revolving credit line, letting homeowners draw funds as needed up to an approved limit, often 80 to 85 percent of equity. It features a draw period—usually 10 years—where only interest payments are required on the amount borrowed, followed by a repayment phase of 10 to 20 years. Interest rates are variable, tied to the prime rate, and recently hovered around 8.5 percent. For a $100,000 HELOC with $50,000 drawn, monthly interest might start at $354, but payments could rise if rates increase. Closing costs mirror those of home equity loans, typically 2 to 5 percent.

Financial Implications and Risks

Both options use the home as collateral, meaning default risks foreclosure—a stark reality for borrowers overextending themselves. Home equity loans offer payment certainty, ideal for one-time costs like renovations, but require interest payments on the full amount from day one. HELOCs provide flexibility for ongoing expenses, such as medical bills, though rising rates can inflate costs.

Choosing the Right Option

The decision hinges on a homeowner’s goals and risk tolerance. A home equity loan suits those needing a set amount—like $60,000 for a roof replacement—with fixed payments over 10 years at 8 percent costing $814 monthly. A HELOC fits uncertain or phased expenses, letting someone draw $20,000 initially for repairs, paying $141 monthly in interest, with room to borrow more later. Current high interest rates, driven by Federal Reserve policies, push some to delay borrowing, as variable HELOC rates are forecasted to go down, while fixed loan rates lock in today’s costs.