HELOC vs. Home Equity Loan: Which Is Better?
For most people, their home is the most valuable asset they own. So, when homeowners need significant amounts of money, they often look to tap into their home equity. A home equity line of credit (HELOC) is one option for achieving this, while a home equity loan is another. The HELOC vs. home equity loan question is a common one, as homeowners often wonder how they differ and which one is better.
When considering the relative merits of a HELOC vs. home equity loan, the most important thing to remember is that neither option is strictly “better” than the other. HELOCs make more sense in certain situations, while home equity loans hold more appeal in others. Understanding how each option works is critical, as both are available to borrowers with stable finances, good credit, and significant amounts of home equity.
Let’s get into the details, so you can decide which option makes the most sense for you.
The Basics of a HELOC vs. Home Equity Loan
HELOCs and home equity loans share some similar features: they both provide access to borrowed capital using your built-up home equity as security. They’re also generally recommended for homeowners with good credit scores and stable incomes. Experts tend to recommend that people with more precarious finances seek alternatives, since both HELOCs and home equity loans can lead to foreclosure if you default on your payments.
A HELOC functions as a type of revolving credit. So, in some ways, it’s much like a credit card. Your HELOC comes with a borrowing limit, and you can draw funds as needed until you reach that limit. You only pay interest on the money you actually borrow, and you can continue to use your line of credit again and again as long as it remains active.
HELOCs usually feature:
- Draw periods of about 10 years
- Repayment periods of about 20 years
- Variable or adjustable interest rates
Home equity loans work a little differently. They advance a lump sum, just like a conventional personal loan. You then repay the borrowed funds in fixed intervals over a set period of time, just as you would on any other loan or mortgage.
Home equity loans usually have:
- Fixed interest rates
- Fixed monthly or quarterly repayment amounts
- Pre-set repayment schedules
When considering a HELOC vs. home equity loan, bear in mind that you’ll need to specify the amount you want to borrow when you apply. With a HELOC, the specified amount will function as the credit line’s maximum limit. With a home equity loan, the requested amount will be released to you in a single lump sum if your application is approved.
A HELOC Might Be Better for You If …
HELOCs and home equity loans are similar, but there are certain situations in which a HELOC may make more sense. For example, if you anticipate a need for funding over an extended period of time, a HELOC could be a good solution. The main advantage of a HELOC is that you only pay interest on the money you actually use. So, it may be better than a home equity loan if you plan to use the funding gradually.
The current low-interest environment shields borrowers from some of the risks associated with variable rates. That said, you do need to plan carefully when drawing down a HELOC, as your interest rate could rise before you finish repaying what you have already borrowed. Thus, your costs are somewhat less predictable than they are with home equity loans.
A Home Equity Loan Might Be Better for You If …
Compared to HELOCs, home equity loans come with greater cost certainty. They typically have fixed interest rates, which are usually higher than the variable rate attached to HELOCs. In exchange for the increased interest, home equity loans benefit borrowers by locking in their monthly or quarterly repayment amounts. This predictability makes financial planning easier. So, home equity loans could be a good fit for homeowners seeking to eliminate guesswork.
Borrowers generally favor home equity loans if they need to finance a major expense or project, such as a home renovation. Personal finance experts often stress the importance of earning some kind of positive return on the capital you borrow, as this safeguards your long-term financial health. Home renovations offer an excellent example: they usually raise the resale value of your home, giving you something in exchange for the interest you paid to finance the improvement project.
Reasons to Use a Home Equity Loan or HELOC
Common uses include:
Financing home renovations
A recent home sentiment study looked into how Americans feel about their homes after spending more time there. One year into the pandemic, only 8.8% of Americans like their homes less and 25.4% like their homes even more. But that doesn’t mean they wouldn’t make any improvements. And arguably, generally liking your home makes investing in renovations even more worthwhile. If you like your home, then you’re less likely to want to move.
If money was no object, then 27.1% of those surveyed would renovate their kitchen and 21.1% would renovate their bathroom. Perhaps you’d like to get new countertops or add more storage. If so, home equity loans and HELOCs are ways to access the cash you need to make home improvements.
Investing in real estate
Demand in the rental market is high and expected to keep rising, so investing in a rental property may be on your mind. If so, then HELOCs and home equity loans are two ways to get funds for a down payment.
Since the current housing shortage is causing rent to skyrocket, it could be a prime time to add a rental property to your investments. That said, the hot housing market means you’ll want to be strategic about where you buy. To make the most of your investment, you’ll want to consider the best places to invest in real estate right now. For instance, home prices in Fayetteville, Arkansas, are 10.2% lower than the national metro average and home values have appreciated 14.8% in the last year. So, finding an emerging housing market could be a win-win.
Paying off higher-interest debt
If credit card bills and other high-interest debts are becoming overwhelming, then you may be considering your options. Since the average American is over $90,000 in debt, carrying substantial debt is incredibly common. So, you’re far from alone if tackling your debt seems like an enormous undertaking.
On the one hand, debt consolidation loans and personal loans are one avenue. And on the other hand, home equity loans and HELOCs are another. Home equity loans and HELOCs typically have lower interest rates, however, they use your home as collateral. It’s important to weigh the relative pros and cons of each option to make the right choice for your situation.
The Bottom Line
HELOCs and home equity loans both offer financially stable, creditworthy homeowners a convenient and reliable way to monetize their home equity. In general, HELOCs usually make a better fit if you need ongoing access to funds and don’t mind variable interest rates. On the other hand, home equity loans often make more sense if you need a large lump sum of money and prefer fixed interest rates.
At the end of the day, the question of HELOC vs. home equity loan comes down to your individual situation. Whichever option you choose, take the time to shop around with multiple lenders and carefully compare offers.