HELOC vs Home Equity Loan: Which Is Better?

HELOCs and home equity loans (HELs) have a lot of things in common. Both loans are mortgages secured by your home. Both offer some of the least expensive financing available, and you follow a similar process to get either loan. But there are distinctions that can make one better than the other for different borrowers. So what are the differences between home equity loans and HELOCs?

HELOC vs Home Equity Loans

The main difference between a HELOC and a home equity loan is the way you receive and repay what you borrow. Here’s a quick rundown. 

HELOC Facts

You might describe a HELOC as a big credit card secured by your home. 

• You do not receive money when you open a HELOC account. Instead, you are granted a line of credit that you can tap when you want, up to its limit.
• There are two phases in a HELOC term – the drawing phase and the repayment phase.
• During the drawing phase, you can use your credit any time and in any amount up to your credit limit. 
• During the drawing phase, your minimum payment equals the interest charge, which is based on the interest rate and your balance.
• During the repayment phase, you can no longer tap the credit line. The lenders sets your payment so that you will zero out the balance by the end of your loan term.
• HELOC interest rates are usually variable, but many programs allow you to fix your rate one or more times during your loan. These are called convertible HELOCs.
• HELOC closing costs tend to be lower than HEL closing costs.

Home Equity Loan Facts

Home equity loans are much simpler than HELOCs.

• HELs are simple installment loans. You receive a lump sum and repay it in monthly installments over the loan’s term.
• Home equity loans usually come with fixed interest rates. 
• Home equity loans often have higher closing costs than HELOCs.

Home Equity vs HELOC: Which Is Better?

Home equity loans and HELOCs have pros and cons that make them better for some loan purposes than others. The loan you choose will probably depend on how to plan to use the proceeds. 

HELOCs are better for these uses:

• Home improvement projects that take place in stages over an extended period
• College tuition when you make payments several times a year
• Backup funding for a small business to prevent cash flow problems
• Emergency line of credit that you don’t tap for anything else
• Smaller loan amounts 
• Ongoing cash needs when you don’t know the exact cost 

HELOCs can get you into trouble if you max them out and then have to repay the balance over a short repayment phase. The monthly payment can rise significantly and catch you off guard. And the variable interest rate can increase your cost unexpectedly.

HELs are better for these uses that require a large sum all at once:

• Debt consolidation to reduce your interest rate and/or monthly payment
• A home renovation when you have to pay a builder upfront
• An expensive medical procedure
• The down payment for another property
• Startup costs for a business
• Big-ticket items like boats or motor homes

Home equity loans can make budgeting easier because their interest rates and payments usually remain the same over the life of the loan.

Which Is Easier to Get: Home Equity Loan or HELOC?

According to Experian, you need a credit score of at least 680 to qualify for most HELs or HELOCs. And both loan products require you to complete a loan application, authorize a credit report, and supply income documentation. 

What about a home appraisal? That depends on the lender, your strength as a borrower, and the amount of equity you have in your home. If you have amazing credit, great income, and a low loan-to-value (LTV) ratio, lenders are more likely to skip the appraisal, 

But if your total loan-to-value (also called combined-loan-to-value or CLTV) would be 80% or higher, and you’re less qualified, lenders will probably require an appraisal. You’ll typically have to pay for it and appraisals add days or weeks to loan processing time. That goes equally for HELOCs and home equity loans. 

Ultimately, the ease of approval depends more on the individual lender’s policies than the type of loan. Some lenders have higher minimum credit scores and LTV limits than others. It pays to compare offers from several providers no matter what kind of loan you’re seeking.

Home Equity Loan vs HELOC Interest Rates

Home equity loans usually come with fixed interest rates and unchanging monthly payments. These interest rates typically run higher than those of HELOCs because fixed rates are riskier to lenders. 

HELOC rates are usually variable and can change over time. Many lenders offer the opportunity to fix your interest rate one or more times during your loan’s term. HELOCs with this feature are called “convertible HELOCs.” Variable interest rates are riskier for borrowers and safer for lenders, so HELOC interest rates tend to run lower than those of fixed-rate HELs. 

Recently, some lenders have stopped offering home equity loans, but they do offer fixed-rate HELOCs. You can use a fixed-rate HELOC like a home equity loan if you take the maximum amount after closing and pay it back in equal monthly installments. Interest rates are quite low for some of these products. A quick online search found HELOCs with fixed rates as low as 3.25% for extremely qualified borrowers. Fixed-rate HELOCs might offer the best of both worlds because you can get a fixed interest rate and flexible terms.

Closing Costs for HELOCs and Home Equity Loans

Closing costs for home equity loans tend to be higher than those of HELOCs. Some lenders waive closing costs altogether for HELOCs. However, closing costs tend to vary more by lender than by product. 

The list of potential costs for HELs and HELOCs includes application fees, credit report fees, title and escrow charges, origination fees, appraisal fees, and recording fees. 

The lender you choose might charge all of these fees or none of them. That’s why it’s important to shop and compare offers from several providers.