HELOC vs Home Equity Loan - Which is Best for You?

Home equity is the difference between the value of your home and what is still owed on it via a mortgage. You can borrow from it in several ways, including through a home equity loan or a home equity line of credit (HELOC). Both options allow you to tap into the equity in your home to use for just about anything you need, often at a lower interest rate than other loans and with easier qualifications.

Understanding the differences between a home equity loan and a HELOC is critical since they provide different features and functions. Depending on what you need the funds for and how long you want access to them, either one of these programs could be right for you.

Before you choose one option or the other, it helps to have more detail on the differences between these lending options to determine when and which one may be best for you.

Home Equity Loan and HELOC Defined

As mentioned above, with both of these loans, your home acts as collateral, which makes it different from a personal loan or a credit card. If you default on the repayment of either loan, your lender could seek legal action against your home, including foreclosure. As such, this type of loan is best only when you are confident in your ability to repay the funds.

A home equity loan typically provides a single disbursement of funds that you can use for various needs. You receive the funds in a lump sum to consolidate your debt, home improvement project, or other needs. You then will set up monthly payments that include interest and the principal and pay off the balance over a set length of time.

In contrast, a HELOC operates somewhat differently because it functions as a type of revolving credit. You can borrow from the HELOC whenever you need to and pay back only the funds you borrow. You cannot borrow more than your credit limit, but you do not have to access the entire dollar amount available at one time.

Key Differences Between HELOC and a Home Equity Loan

Some key differences apply to HELOC and home equity loans, and it is wise to thoroughly evaluate each before deciding which to use.

Flexibility in accessing funds

With a home equity loan, you’re given the funds at one time, and you decide what to do with them at that point. With a HELOC, you have a credit line based on your home’s equity value. You don’t have to take everything out at once, and you can borrow just what you need when needed. Then, you can borrow from it down the road when you need to do so again.

How the loan is structured

Home equity loans are designed to provide a lump sum. In some cases, that could be helpful, especially if you need a significant amount of money at one time. Also, note that a lump sum could help you minimize the need to continuously tap into your home’s equity for the draw period. If you don’t want or need to access a large amount to cover a significant expense and instead would rather have more flexible access to funds, a HELOC may be a better option, allowing you to only use what you need when you need it.

Interest rates of the loan

The interest rate charged depends on multiple factors. One common difference between a HELOC and a home equity loan is what happens to that rate over time. With a HELOC, the interest rate is variable, which means it could go up or down over time. It adjusts based on several factors, including the changes in the Prime Rate set by the Federal Reserve. This can impact the amount you owe over time if rates increase.

On the other hand, a home equity loan may have a fixed interest rate. That means you agree to the rate in advance, which remains the same from the first day until the final payment. This type of structure can benefit those who value consistency, are happy with the current rate, and don't want to risk it increasing.

Pros and Cons of Each Loan Option

There are some great benefits to using either a home equity loan or HELOC, including the fact that both are secured loans. This helps to keep the overall cost down with interest rates that tend to be much lower than a credit card. Consider some of the pros and cons of each of these loans.

Pros of home equity loans:

• You know what your payment will be every month, creating stability and clarity.
• Borrow a lump sum to help with big investment needs, including debt consolidation or a home improvement project.

Cons of a home equity loan:

• The interest rate is fixed and is not negotiable if rates fall over the life of your loan.
• It's all or nothing, as you don't get the option to borrow only the funds needed now. You will pay the lender over time as a second mortgage on your home without the ability to borrow again through the same loan.

Pros of a HELOC:

• Borrow and pay back just what you need based on your home’s equity value. That creates a backup reserve of cash you can use when there is a need to do so.
• You only have to pay interest payments during the initial part of the loan, which tends to keep the monthly payment much lower.

Cons of a HELOC:

• There is the need to repay the funds over time, which may be longer than the loan term with a home equity loan due to interest only payments.
• The borrowing power of a HELOC is only the amount up to your credit limit, and it remains available to you for a set length of time.

Both options could be a good fit for some borrowers. But remember that overall, your home’s equity will help you save money with interest rates that are more affordable than even the best credit cards.

Factors to Consider Before Choosing HELOC vs. Home Equity Loan

As you think about the options available, consider your situation carefully. Consider how you plan to use these funds and which method may best suit your needs.

Review your current financial situation

If you have a good credit score and want to borrow funds to help you consolidate your debt, consider what may work for you right now:

• Do you need a large sum of money at one time to consolidate debt like a personal loan?

• Do you want backup funding for when you need it and may not immediately need a large amount, making a home equity line of credit a better choice?

Understand the impact on your home’s equity

It is always important to think about your home’s value. An equity loan or HELOC will have a lower interest rate than a personal loan or credit card, making it more affordable. More so, you can use this loan for just about anything you need to use it for, including home improvement, debt consolidation, a down payment on another purchase, a student loan, or other factors.

While both offer excellent features, it is still a financial investment leveraging the value of your home. If there is any risk that you may not actually be able to repay the loan, home equity financing could be risky, as it is gambling the roof over your head.

Consider the long-term implications of both options

A HELOC or home equity loan could provide excellent borrowing flexibility. Think about the long term as you consider your options.

A home equity loan could help you consolidate debt, reducing the overall cost of borrowing by paying off your credit cards or other loans. Over the long term, you’ll carry that debt until you pay it back. That could be ten years or longer. If you do not use more credit, this could be a very affordable way to save money. 

By comparison, a HELOC will likely have a smaller credit line to worry about unless you use the full balance. That could mean smaller monthly payments, too. You can pay it off sooner, but with the flexibility of interest-only payments, you may find this method very affordable overall if you want low payments over time.

Your Credit Score and Eligibility for a Home Equity Loan or Line of Credit

You must show the lender you can repay the loan through income to obtain either of these loans. You also need a credit score showing you can make wise financial decisions. Every lender sets their own credit score to qualify for these loans. Overall, credit score requirements are lower for secured loans than for personal loans.

Before you apply, think about:

• What is your current credit score, and can you do anything to improve it in the short term?

• How much home equity do you have right now, and what are your needs for those funds?

• If you have a higher credit score, that could mean a lower interest rate, saving you money.

• A good credit score could help you get home equity financing with a lower interest rate than what you pay on your existing debt, saving you money.

If you are unsure if you have enough credit or equity, contact your lender to inquire about your options. You’ll get hands-on insight from an experienced professional in determining your eligibility.

Planning for Potential Life Changes or Financial Emergencies

As you think about the options available to you in these home loans, consider what could happen in the future. Here are a few things to think about before moving forward:

• If you were to use home equity financing, you could reduce the interest you pay across all of your debt if you qualify for a lower rate.

• With a HELOC loan, you can borrow just when you need to. That could create a strong emergency resource you can borrow against when you need to do so.

• The variable interest rate of a HELOC could be a factor for some. If interest rates rise, you could pay more over time for the funds. A higher loan payment could be limiting to some people.

The best HELOC lenders will make sure you understand the importance of financial planning. As with all loans, you must be able to make your loan payment reliably.

Finding the Right Option for You: HELOC vs. Home Equity Loan

As a secured loan, all types of equity are valuable and tend to be affordable ways to borrow. HELOCs provide a line of credit from the lender that you can use over time. By comparison, a home equity loan could be a good option for those who need a large sum upfront.

Before making any decision, seek the help of a financial advisor who can consider factors related to your situation.

Let Triad Bank offer you the guidance you need. Contact us today to speak to a lender about the availability of a HELOC or a home equity loan that fits your goals.

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