HELOC vs. Home Equity Loan: How to Tap Into Your Home’s Equity
Thinking about tapping into your home equity?
If you’re looking for ways to finance a home renovation, consolidate debts (hello, student loans!), or fund a big purchase, you might be on the right track. Your home equity could give you quick access to large sums of money, often at a lower interest rate than a credit card or personal loan. There can be potential tax benefits, too.
But there are several ways to leverage your home equity, including a home equity line of credit (HELOC) and a home equity loan. So which option is right for you? And how do a HELOC vs. home equity loan compare?
In this article we’re sharing everything you need to know about the most popular ways to tap into your home equity, including pros, cons, and common use cases.
What Is a Home Equity Loan?
A home equity loan is a type of loan that allows you to borrow money against the value of your home. Your equity, or the difference between your home’s value and the amount you own on your mortgage, acts as collateral for the lender. Home equity loans give you a lump sum of money, then you repay it over time with fixed monthly payments at a fixed interest rate.
Home equity loans are often used for home improvements, education costs, business investments, and more.
What Is a Home Equity Line of Credit (HELOC)?
A home equity line of credit (HELOC) is a loan that lets you borrow money against the equity of your home on a revolving basis, similar to a credit card. You can use funds as needed up to a set limit of time, which is usually between 5 to 10 years. You’ll make interest-only payments during this period then be required to pay back principal and interest over the repayment term.
HELOCs are most commonly used for large, ongoing expenses, such as home renovations, emergency needs, medical bills, or real estate investments.
Home Equity Line of Credit vs. Home Equity Loan
A HELOC vs. home equity loan may sound similar, but they’re two distinct options with unique pros and cons. To determine the best fit for you, first consider what you’ll be using the equity for.
And remember: If you can, it’s always better to save for big expenses rather than tap into your home equity. When you wait to make home upgrades until you can afford to pay cash for them, you’re guaranteed to pay less than using a HELOC or home equity loan.
Home Equity Loan
Also referred to as a second mortgage, a home equity loan is given to you from the lender all upfront. Then you repay it at a fixed interest rate over a set period of time, referred to as a “term.”
Because a home equity loan is paid in a lump sum, you should be ready to start paying interest on the entire balance.
“Unless you’re using the loan to make repairs or improvements to your home, it is usually not a great idea,” said Randall Yates, CEO of The Lenders Network. Investing that money back into your home will help increase its market value, but Yates cautions people against using it to repay debt.
“Using the funds to pay off unsecured credit card debt is risky, because if you face financial problems, your home is in jeopardy of being foreclosed on,” he said.
Ultimately, if you’re using your equity for a one-time expense or if you know exactly how much you’ll need to take out, a home equity loan could be a good option.
Home Equity Line of Credit (HELOC)
If you don’t know how much money you need or how long you’ll need it for, a HELOC might be a better option. Your lender gives you a borrowing limit, and then you can take as little or as much as you need whenever you want.
“The advantages to it are you only pay on the money you borrow,” said Ralph DiBugnara, president of Home Qualified. “Think of it like having a low-interest credit card on your home.”
The downside: Interest rates for HELOCs are typically adjustable and are often higher than rates for a home equity loan.
Other Options to Tap Into Your Home Equity
If a home equity loan and a HELOC don’t seem like the right fit, you may want to consider other options, like a cash-out refinance or reverse mortgage.
Refinancing
With a cash-out refinance, you refinance your first mortgage with a mortgage that’s slightly more money than your current one, and then pocket the difference.
You can usually get lower interest rates and monthly payments, but because the cash is rolled into the term of your entire mortgage, in the long run you’ll pay more in interest over the life of the loan unless you pay off your home early.
Reverse Mortgage
Another option you may be familiar with (from its robust advertising budget) is a reverse mortgage.
The majority of reverse mortgages are actually home equity conversion mortgages, or HECMs. These are federally insured mortgages, similar to home equity loans. They allow homeowners 62 or older to tap into a portion of their equity and usually don’t need to be paid back while the person lives in their home.
Advertisements make a reverse mortgage look like a great option for seniors, but the reality is less sweet. Because homeowners aren’t required to make payments toward the loan, interest compiles, and the loan balance can balloon quickly. This often makes them the most expensive way to access home equity.
Many people think a reverse mortgage will cover them until they die, but depending on the age of the homeowner and value of the home, someone can easily outlive their equity.
Should You Tap Into Your Home Equity?
Tapping into your home equity is a big decision — one that should be considered carefully and responsibly. If you’re deciding between a HELOC vs. home equity loan, be sure to talk to a financial advisor to help determine the best route for your situation. Remember that defaulting on the loan could lead to foreclosure, so it’s important to understand the terms and risks before proceeding.
Jen Smith is a staff writer at The Penny Hoarder. She gives money-saving and debt-payoff tips on Instagram at @savingwithspunk.
