HELOC vs. Home Equity Loan: Which One Is Better?

With home values reaching new heights, many homeowners are considering using the equity in their homes to fund home improvement projects or cover other expenses. Both home equity loans and home equity lines of credit (HELOCs) offer ways to tap into your home's value. Let's explore the differences between HELOCs and home equity loans, so you can better understand how each option may fit your needs. 

What Is Home Equity? 

Home equity is the portion of your home that you actually own after deducting your remaining mortgage balance.

For example, if your home is worth $400,000 and you’ve already paid off $80,000 in mortgage debt, you would have $80,000 in equity right away. Over time, your equity grows as you make regular payments, which reduce your loan balance (the principal) and contribute to building your equity. Additionally, if the value of your home increases, your equity grows accordingly.

For example, if the housing market changes and your $400,000 home rises in value to $450,000, you would gain an additional $50,000 in equity.

Home Equity Loan Vs. HELOC At A Glance

Before diving into the details, let’s take a quick look at how HELOCs and home equity loans compare at a glance. 

Home Equity Line Of Credit (HELOC)

A home equity line of credit (HELOC) is a revolving credit option that lets you borrow against your home’s equity for a variety of needs. Unlike a home equity loan, which provides a lump sum upfront, a HELOC allows you to borrow as needed, up to a predetermined limit, and repay over time. 

How HELOCs Work 

A HELOC works much like a credit card. It allows you to borrow as needed, up to your credit limit, during the draw period instead of receiving a large lump sum upfront. As you repay the money, your available credit is replenished, and you can borrow again.

An important HELOC benefit is that you can make interest-only payments during the draw period. This could make it easier to manage your cash flow or keep your payments lower if your budget is tight.

Understanding The HELOC Timeline 

There are two phases to a HELOC. Understanding the difference between the HELOC draw period vs. repayment period may help you better plan how you use your available funds. Together, these two periods typically last about 20 years.

The draw period is the time when you can access funds from your HELOC, and it usually lasts about 10 years. During this time, you can make interest-only payments or pay down what you’ve borrowed to restore your available credit and borrow again if needed.

After the draw period ends, you’ll move into the repayment period, which typically lasts about 10 years. During this time, you can no longer borrow from the HELOC, and you’ll begin repaying the remaining balance plus interest through fixed monthly payments.

HELOC Considerations

Before applying for a HELOC, it’s essential to understand the risks. Like any loan secured by your home, a HELOC puts your property at risk if you're unable to make payments. Additionally, a HELOC typically has a variable interest rate, meaning your payments could change based on market conditions. This could result in higher payments if interest rates increase. You also reduce the amount of equity in your home when you use a HELOC because you're increasing the debt that's tied to your property.

HELOCs also have variable interest rates during the draw period. If rates increase, your cost of borrowing may increase. A HELOC may also come with closing costs and other fees.

When A HELOC Makes Sense

A HELOC may be a good fit when you want flexible access to funds and you don’t need all of the money at once. It could also be helpful for ongoing or unpredictable expenses, like home renovation projects or unexpected repairs. This flexibility allows you to borrow only what you need and pay interest only on the amount you actually use.

For example, if you want to replace the flooring in your home but you plan to work on one room at a time, a HELOC offers a more flexible way to borrow. Instead of borrowing a lump sum of $12,000 for six rooms, you might borrow $2,000 at a time to complete each room as your budget allows. This approach may also help you save on interest since you’re only paying interest on the money you actually use.

Home Equity Loan

A home equity loan, like a HELOC, is secured by the equity in your home. However, rather than acting as a revolving line of credit, a home equity loan provides a lump sum that you repay in fixed monthly payments over a set term, typically ranging from 5 to 30 years.

How Home Equity Loans Work

With a home equity loan, you borrow a set loan amount, and then start making payments right away. These loans have fixed interest rates that don't change based on market conditions. This predictability may help with budgeting since your monthly payment stays the same.

Because home equity loans are backed by the equity in your home, they may have lower interest rates than unsecured loans, like personal loans and credit cards. They may also give you longer to repay the money you borrow, which could give you more flexibility in your budget.

Home Equity Loan Considerations

Home equity loans carry similar risks to HELOCs, as they are secured by your home. If you miss payments, there’s a risk that you could lose your home. Additionally, borrowing against your home reduces your available equity. These loans may also come with closing costs and other fees, and borrowing against your equity means you’ll temporarily have less ownership in your home until the loan is paid off.

Another thing to keep in mind is that home equity loans provide a lump sum upfront. If unexpected costs pop up later, you may need to take out another loan. For example, you may need extra funds to finish a bathroom renovation if you discover damage beneath the flooring.

When A Home Equity Loan Makes Sense

A home equity loan may be a good choice when you know exactly how much you need to borrow and you want predictable monthly payments. One of the key home equity loan advantages is the stability of fixed payments, which could make budgeting easier. This option may work well for one-time expenses like replacing a roof, debt consolidation or purchasing new appliances.

Some homeowners also use home equity loans to consolidate high-interest debt, like credit card debt. By rolling multiple balances into one loan, you may secure a lower interest rate and simplify your payments. Longer repayment terms may also lower your monthly payment and give your budget more breathing room.

HELOC And Home Equity Loan Requirements

Before applying for a HELOC or home equity loan, you should understand the general eligibility requirements. This enables you to gather your documents before you apply, which may help you avoid delays.

We typically look for:

• Sufficient home equity: It’s often a requirement to have at least 15%–20% equity in your home.

• Credit score: Another determining factor on a loan approval is a minimum credit score of mid-600s or higher. Keep in mind that better scores may qualify for lower interest rates and better terms.

• Stable income and employment: You’ll need to verify that you have a steady income to ensure you can repay the loan. This may include pay stubs, tax returns or proof of self-employment income.

• Debt-to-income ratio: As a lender, we typically prefer that your DTI ratio, which is the percentage of your gross monthly income used to pay debt obligations, does not exceed 43%.

• Verified home value: Your home will be appraised to confirm its current market value and determine how much equity you have to borrow against.

• Homeowner’s insurance: We may ask for proof of homeowner’s insurance coverage since the loan is secured by your home’s equity.

Explore Your Home Equity Options

Ready to take the next step? Connect with one of our loan specialists to discuss whether a home equity loan or HELOC is the right choice for your goals. We’ll be glad to review your financial information, answer your questions and guide you through the application process.

Just give us a call at 623.580.6000 or fill out and submit the form below to get started.👇

HELOC & Home Equity Interest Form

This article is intended to be a general resource only and is not intended to be nor does it constitute legal advice. Any recommendations are based on opinion only.

¹APR=Annual Percentage Rate. Rates, terms and conditions are subject to change and may vary based on credit worthiness, qualifications and collateral conditions. All loans are subject to approval. Rate shown is for 60 month term. 120 and 180 term loans are also available. Contact us for details. Minimum amount: $15,000 - Maximum amount: $350,000. Property insurance is required and will be verified. No prepayment penalty. An origination fee of $300-$800 will apply based on your total loan amount. Membership is required.

²All loans subject to approval. Rates, terms and conditions are subject to change and may vary based on creditworthiness, qualifications and collateral condition. No prepayment penalty. Property insurance is required and will be verified. APR=Annual Percentage Rate. APR: minimum is 4.00% and maximum is 18.00%. Minimum amount: $15,000 and maximum amount: $350,000. The index will be adjusted monthly as of the first day of each billing cycle following an index change. Prime Rate is 6.75%. Floor Rate is 4.00%.