HELOC vs. home equity loan: Compare pros and cons

October 14, 2022 - 13 min read

HELOC vs. home equity loan

HELOCs and home equity loans allow you to cash out equity without refinancing. A home equity loan gives you a lump sum of cash upfront, while a HELOC creates a line of credit that you can tap as needed, like a credit card.

With home values up nationwide, homeowners are sitting on record amounts of equity. Either a HELOC or home equity loan could be a great way to turn that pent-up wealth into cash.

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HELOC vs. home equity loan: Similarities

Home equity loans and home equity lines of credit (HELOCs) are both “second mortgages.” That means the loan is secured by your home’s value but is separate from your primary mortgage. If you’re still paying down your original home loan, the HELOC or home equity loan will create a second payment on top of your existing mortgage payment.

Whether you use a HELOC or a home equity loan, the amount you can borrow is determined by the same factors: your home’s value, your existing loan amount, and your financial situation (credit score, income, interest rate, etc.).

To determine how much you can borrow on a HELOC or home equity loan, the lender will calculate your home equity by subtracting your existing loan balance from your home’s current market value. For either loan type, the combined value of your primary mortgage and your second mortgage usually can’t exceed 80-85% of the property value.

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HELOC vs. home equity loan: Differences

Although HELOCs and home equity loans both fall into the second mortgage category, the way they work is very different.

When you take out a home equity loan, you receive a one-time, lump-sum payment at closing for the entire loan amount. You’ll make regular monthly payments on this loan until it’s paid off. In this way, a home equity loan closely resembles a standard mortgage.

HELOCs work differently. When you take out a HELOC, it opens a line of credit that you can use and repay on an as-needed basis. Your lender will determine a maximum HELOC amount up to which you can borrow; this is your credit limit, just like on a credit card.

Unlike a home equity loan, you won’t start repaying a HELOC right away. Instead, you’ll have a draw period (usually 5-10 years) during which you can use the credit line and make only minimum interest payments. After that, you’ll enter a repayment period during which you can no longer use the credit line and must repay any outstanding loan balance.

HELOC interest rates are usually variable, unlike home equity loan rates, which are usually fixed.

HELOC vs. home equity loan: Features

Home Equity LoanHELOC
Loan TypeSecond mortgage Second mortgage
StructureOne-time payoutReusable credit line
Interest RatesFixedVariable 
Max. Loan Amount*80-85%80-85%
Best ForLarge one-time cost (e.g. remodel) Ongoing expenses, emergency funds 

*Maximum HELOC and home equity loan amounts vary by lender. Your loan amount depends on your personal finances and current interest rates.

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Qualifying for a HELOC or home equity loan

HELOC requirements and home equity loan requirements tend to be a little stricter than standard mortgage guidelines. For one, many lenders require a good credit score of 680 or higher. And you’ll get better interest rates with a score above 700.

“A score of 620 or lower will make it hard to secure a home equity loan or HELOC,” says Theresa Williams-Barrett of Affinity Federal Credit Union. “Higher scores may provide access to higher loan amounts and lower costs.”

You also need to be confident in your earnings and job security. “Establishing a secure, constant source of income is very important,” Williams-Barrett says. As with all mortgages, HELOC and home equity loan lenders will check your employment, W-2s, paystubs, and debt-to-income ratio (DTI) to verify that you can afford the loan.

HELOC vs. home equity loan: Pros and cons

As you decide between a HELOC and a home equity loan, consider the pros and cons of both types of borrowing.

HELOC pros:

  • Interest is charged only on the amount drawn from the line of credit
  • If you don’t use the credit line, you pay nothing
  • Can be paid off and reused throughout the draw period
  • Ideal for ongoing expenses, creating additional cash flow, and emergency funds
  • Some lenders charge no closing costs

HELOC cons:

  • Variable interest rates make repayment less predictable
  • Variable interest rates can increase your total cost if the prime rate rises
  • Line of credit ties up equity even when you haven’t drawn from it

Home equity loan pros:

  • Fixed interest rate and fixed payments
  • Simplicity of an installment loan
  • Single disbursement is ideal for big projects, purchases, or debt consolidation

Home equity loan cons:

  • Less flexibility than a home equity line of credit (HELOC)
  • Interest is charged on the full loan amount, no matter how much of it you use
  • Lenders may require higher credit scores than for traditional mortgages
  • Closing costs can be higher than for HELOCs

In addition, note that interest paid on both home equity loans and HELOCs may be tax-deductible if you use the money to purchase or improve a home. Check with a tax professional to learn more.

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What’s better, a home equity loan or a HELOC?

When it comes to HELOCs vs. home equity loans, how do you know which one is better? Jed Mayk, attorney and partner with Hudson Cook, LLP says that depends on your needs.

“A home equity loan might make more sense for a borrower who needs a set amount of money for a specific purpose,” he says. “This can include a home improvement project.”

A home equity loan also tends to be a better fit for needs such as:

  • Debt consolidation
  • Extensive home renovation requiring a large upfront payment
  • Investing in real estate

But a home equity loan may not be the best choice “if you are unsure of the exact amount you may need now or in the future,” says Johnna Camarillo with Navy Federal Credit Union.

A HELOC might make more sense for those who need to borrow different amounts over an extended period of time.

Examples of good uses for HELOCs include:

  • Regular tuition payments
  • Extended “pay as you go” home improvements
  • Providing cash flow for a new business
  • Creating an emergency fund if you’re short on savings

HELOCs are best for those who don’t need instant access to their home’s equity.

“A HELOC can be used like a credit card. It’s great to have as a rainy day fund if your home needs emergency repairs,” Camarillo says.

Mayk says HELOCs are also popular with folks who have irregular income patterns. “This includes those paid a base salary and quarterly commissions.”

How much can I borrow with a home equity loan or HELOC?

Not all lenders offer home equity loans or HELOCs. And the ones that do typically limit the amount you can borrow to only a portion of your home equity.

Maximum HELOC and home equity loan amounts are based on your home value and your existing mortgage. Most lenders cap your combined loan-to-value ratio (CLTV) at 80 or 85 percent. That means you can’t borrow more than 85% of the home’s value when both mortgages are added up.

For example, an 85% loan limit on a $300,000 home means the homeowner can hold only $255,000 in total mortgage debt ($300,000 x 0.85 = $255,000).

If the primary mortgage has a $200,000 loan balance, that leaves only $55,000 for the second mortgage.

Here’s a simple breakdown of this math from start to finish:

  • Home’s appraised value: $300,000
  • Existing mortgage loan balance: $200,000
  • Max. loan amount (85% of value): $255,000
  • Equity available (max. loan amount minus current loan): $55,000

Lenders enforce CLTV limits because it forces homeowners to leave some equity untouched. This provides a financial cushion and protects lenders from loss in case a borrower defaults on their loan.

Not all homeowners will be able to borrow the maximum amount of equity available. Your loan amount depends on your credit score, credit history, and debt-to-income ratio, among other factors.

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Additional ways to borrow from home equity

HELOCs and home equity loans aren’t the only ways to borrow against the value of your home.

Cash-out refinance

Rather than taking out a second mortgage, a cash-out refinance replaces your existing home loan with a new, larger mortgage. The new loan is used to pay off your current mortgage and the ‘extra’ amount is cashed out to you at closing.

Most mortgage lenders cap the amount you can borrow on a cash-out refinance at 80% of your home’s value. (The exception is VA cash-out refinancing, which allows a 100% loan-to-value ratio.)

Back to our example of a $300,000 home with $200,000 still due on the mortgage:

  • Home value: $300,000
  • Maximum refinance loan amount: $240,000 (0.8 x 300,000)
  • Subtract existing mortgage balance: $240,000 - $200,000
  • Maximum cash-out: $40,000 (minus closing costs)

Cash-out refinancing has some distinct benefits. It gives you one mortgage payment instead of two; interest rates are typically lower than for home equity loans or HELOCs; and if you’re paying a higher interest rate on your existing mortgage, you could save a lot by locking in a lower rate or a shorter term.

“This is an attractive option if doing so lowers your interest rate,” Camarillo suggests.

When mortgage rates are rising, however, cash-out refinancing becomes a lot less attractive. If a cash-out refinance would increase the mortgage rate on your entire loan balance, then borrowing part of your equity with a HELOC or home equity loan is likely a better option.

Although the interest rate on a HELOC or home equity loan is usually higher than a cash-out refi, your loan amount will be smaller, leading to a lower loan payment.

Convertible HELOC

Convertible HELOCs come with an additional feature — the conversion option. At some point during the loan’s lifetime, you could convert your variable-rate HELOC to a fixed-rate home equity loan.

Your HELOC may already have a conversion option; some even give you more than one chance to convert during the life of the loan.

Keep in mind this may not be a great deal. The fixed-rate repayment period after the conversion may be longer, stretching out interest payments over a longer period of time. Also, at times, a variable interest rate is preferred to a fixed rate. And a convertible HELOC may charge higher fees.

Still, this is an option worth considering if you’d like a hybrid between a variable-rate HELOC and a fixed-rate HELOAN.

When shopping for a HELOC with a conversion option, ask lenders these questions:

  • Is there a charge for the conversion? If so, how much is it?
  • Will I be able to use the remaining credit available on the line after a conversion?
  • Does the loan convert to a new fixed loan (for example, with a 30-year term), or is the balance amortized over the remaining term of the existing loan?
  • How many times can I convert?
  • How often can I convert?
  • What determines the new fixed interest rate?

As always, make sure you fully understand the terms of the loan and the total long-term cost before signing on.

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HELOC vs. home equity loan FAQ

Is a HELOC or home equity loan better? 

A home equity loan may be better for a big, one-time expense like medical bills or high-interest debt consolidation. HELOCs are better when you want a flexible source of cash that you can tap as needed. Because a HELOC is a line of credit, you only have to pay off the amount you decide to use.

What is home equity?

Home equity is the portion of your home’s value that you own. Put another way, it’s the amount of your home’s value you don’t owe to a lender. To calculate your equity, subtract the amount you owe on your current mortgage from the market value of your home. The amount of equity in a home fluctuates over time as you pay down your mortgage loan and as the value of the property goes up.

How much can you borrow against the equity in your home?

Homeowners can typically borrow 80 to 85 percent of their home’s appraised value using a home equity loan, minus what is owed on their first mortgage. This amount can vary according to your credit score.

How do home equity loans and HELOCs work?

A home equity loan offers a one-time, lump-sum payout. It is repaid in installments over a fixed time period. A home equity line of credit (HELOC) is a bit more complex. During the first few years, you can draw from the line of credit and make interest payments only on the amount withdrawn. After that, you’ll enter a repayment period when the remaining balance needs to be paid in full.

Are home equity loans and HELOCs a good idea?

A HELOC or home equity loan can be a good way to convert the equity you’ve built up in your home into cash, especially if you invest that cash in home renovations that increase the value of your home. But always remember, you’re putting your home on the line. If real estate values decrease, you could end up owing more than your home is worth. Should you then want to relocate, you might end up losing money on the sale of the home or be unable to move.

Does a home equity loan hurt your credit?

Home equity loans may impact your credit score. However, home equity lines of credit (HELOCs) tend to have a bigger impact on credit scores. Whether the impact is positive or negative typically depends on how much you owe compared to the available credit limit.

What credit score is required for a home equity loan?

Most lenders require a minimum credit score of 620 for a home equity loan. Other lenders may require scores as high as 700. As with other mortgage loans, the better your credit score, the better your interest rate and loan terms.

Are home equity loans tax-deductible?

The interest paid on a home equity loan or HELOC might be tax deductible if the funds were used to buy, build, or substantially improve your home. If the funds were not used for any of these purposes, interest is not tax-deductible. In addition, you can only deduct mortgage interest if you itemize your tax deductions instead of taking the standard deduction. Consult a tax professional to find out whether mortgage tax deductions apply to you.

Is there a penalty for paying off a home equity loan early?

Most home equity loans do not have a prepayment penalty. However, some HELOCs do have penalties that are designed to recapture loan closing costs your lender may have originally waived.

Start your HELOC or home equity loan

With home values on the rise, many homeowners have gained tens of thousands in equity over the past few years.

A home equity loan or HELOC can be an affordable way to unlock this equity — especially if your current mortgage has a low interest rate and you don’t want to replace it. Compared to other forms of borrowing, such as high-interest credit cards or unsecured personal loans, these loans also provide very attractive interest rates.

If you want to tap home equity without refinancing, a HELOC or home equity loan could be a great solution. Contact a lender to see your options and interest rates.

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Maggie Overholt
Authored By: Maggie Overholt
The Mortgage Reports contributor
Maggie Overholt is a former Editor at The Mortgage Reports, where she helps make complex topics more approachable. She has also written for publications specializing in insurance and personal finance.