HELOC Versus Home Equity Loan: What’s Best?

Do you wonder whether a HELOC or a home equity loan will work best for you? Learn about the advantages and disadvantages of each of these loans.

If you’re looking to tap into your home’s equity, you’ve likely come across two options: a home equity loan and a home equity line of credit (HELOC). Both allow you to access the value of your home to meet financial goals, but they work in different ways. Choosing the right option depends on your financial needs and circumstances.

In this home equity loan vs HELOC guide, you’ll learn how each option works, their pros and cons, and when you might (or might not) use them.

Home Equity Loan

What It Is

A home equity loan, also known as a second mortgage, lets you borrow a lump sum using the equity in your home – your property’s value minus what you owe.

Many prefer this type of consumer debt because of its fixed interest rate throughout the entire loan term. This provides financial stability and makes it easier to manage your finances.

How It Works

When you apply for a home equity loan, lenders assess your home’s value and available equity. A typical loan range is usually 80%-90% of your home’s combined loan-to-value ratio (CLTV). Your credit score, income, and payment history also affect the amount you’re able to borrow. Once approved, you’ll receive the full loan amount upfront, which you repay in fixed installments over a set term, usually 5 to 30 years. Get all the details on how a home equity loan works here.

While a home equity loan allows easy access to some cash, you should carefully consider your decision. Remember that your home is the loan’s security, and any defaults could result in its loss.

Home equity loans are typically used for large, one-time expenses, such as the following:

• Funding major home renovations like a kitchen remodel or roof replacement
• Covering unexpected healthcare costs without dipping into savings
• Consolidating debt and paying off high-interest credit cards
• Education expenses with a predictable repayment schedule

Home Equity Loan Application

HELOC

What It Is

A HELOC is a revolving line of credit secured by your home’s equity. Unlike a home equity loan, which provides a lump sum upfront, a HELOC allows you to borrow money as needed, up to a set credit limit.

How It Works

There are two primary phases: the draw and repayment periods. During the draw period, which typically lasts 5 to 10 years, you can borrow as much or as little as you need, only paying interest on the amount you use. After the draw period ends, the repayment period begins, during which you repay both the principal and interest. The repayment phase usually lasts 10 to 20 years.

Due to borrowing flexibility, HELOCs are great for managing unexpected expenses like medical bills. However, the ease of getting the money, just like with credit cards, can lead you to overspend if you don’t plan well. Also, HELOCs often come with variable interest rates, meaning your monthly payments could change over time.

HELOCs are often used for the following:

• Phased home renovation projects like landscaping or adding rooms that require long-term funding
• Providing quick access to funds for unexpected costs like medical bills
• Managing short-term financial needs without committing to a lump-sum loan

HELOC Application
 

Key Differences Between HELOCs & Home Equity Loans

HELOCs and home equity loans primarily differ in structure, interest rates, and repayment terms.

Structure

A HELOC offers a revolving credit line that allows you to continuously borrow money up to a specific credit limit over some time. In contrast, a home equity loan offers you a lump sum to be paid back within a specified duration.

Interest Rates

The interest rates for HELOCs are variable, meaning they can change over time. However, the interest rates for a home equity loan are fixed and don’t change for the duration of the loan.

Repayment Terms

With home equity loans, you pay the same monthly installments until you clear the loan. However, with HELOCs, your monthly repayment varies depending on your outstanding balance and interest rate.

Purpose

A HELOC is ideal for ongoing expenses or phased projects that require a continuous supply of funds, such as renovations. On the other hand, a home equity loan is good for large one-time expenses, such as debt consolidation.

Pros & Cons Of HELOCs

Here are the main pros and cons of HELOCs.

What Are The Pros Of HELOCs?

• They offer flexible loan terms, allowing you to borrow what you need when needed without committing to a large lump sum upfront.
• HELOCs offer high loan limits, usually five or six figures. They’re ideal for large ongoing expenses like medical treatment or home renovations.
• Unlike home equity loans, HELOCs often have lower upfront fees, making them a cost-effective choice for many borrowers.
• They typically offer lower rates compared to other loan types, such as credit cards or personal loans.

What Are The Cons Of HELOCs?

• HELOCs usually have variable interest rates. This means your payments can rise if market rates increase.
• The revolving credit nature of HELOCs makes it easy to overspend, which can lead to financial problems.
• Interest-only payments during the draw period might lead to higher payments when the repayment phase begins.
• Like a home equity loan, defaulting on a HELOC puts your property at risk since the loan is tied to your home.

Pros & Cons Of Home Equity Loans

Home equity loans have several advantages and disadvantages, including the following:

What Are The Pros Of Home Equity Loans?

• Since these loans have fixed rates, they keep your monthly payments steady, making budgeting easy.
• The interest on a home equity loan is often lower than those on credit cards or personal loans, saving you money.
• A home equity loan is ideal for funding large, one-time expenses with clear upfront costs due to the huge initial lump sum.

What Are The Cons Of Home Equity Loans?

• Borrowing more than you need could strain your finances if unexpected costs arise.
• Payments start immediately, regardless of how or when you use the funds.
• Defaulting on the loan puts your property at risk.

What’s Not A Good Use Of A HELOC & Home Equity Loan?

• Non-essential expenses like vacations or luxury items. It’s better to save for these types of expenses.
• Short-term needs – personal loans or credit cards are better for smaller, short-term expenses.
• Risky investments like stocks or startups that don’t have guaranteed returns.
• Using home equity for everyday expenses is not advisable because this can cause long-term financial instability.

Make The Right Financial Decision With A+FCU

A home equity loan and HELOC allow you to tap into your home’s value, but they serve different needs. A HELOC offers flexibility with a credit line for phased projects, while a home equity loan provides a lump sum for large, one-time expenses.

At A+ Federal Credit Union, we offer flexible loan options to meet our member’s financial needs. Whether you’re considering a home equity loan or a HELOC, we’re here to help. Enjoy our competitive interest rates and save more with our loan products. Further, our mortgage team will guide you as you choose the best product for your needs.

Contact A+FCU today and take the next step toward making your home’s equity work for you.

Membership required. LTV = Loan to Value. Programs, rates, terms, and conditions are subject to change without notice. Normal lending criteria apply. All loans subject to credit approval. Property must be located in Texas and primary owner-occupied single-family residence. $495 processing fee for loans less than $40,000. $795 processing fee for loans $40,000 and above. HELOC maximum loan amount of $250,000. NMLS #405608.