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Home equity loan vs. HELOC: Which is best for borrowing against your equity?

Dori Zinn
Updated
Home equity loan vs. HELOC: Which is best for borrowing against your equity?

Americans with mortgages hold a record $17.2 trillion in home equity, according to updated ICE Mortgage Monitor data. If you’re among homeowners who’ve seen your home value soar, tapping into your home equity offers a way to borrow money at lower rates than you’d find with personal loans or high-interest credit cards, especially after the Federal Reserve's long-awaited rate cuts.

Among your options are a home equity loan or a home equity line of credit (HELOC) that you can use to pay for significant or unforeseen expenses. Here’s how they compare — including benefits, drawbacks and how rates work — to find the best for your needs, budget and creditworthiness.

Home equity is how much of your home you own compared to what you owe — or what’s left — on your mortgage. You can calculate your home equity by taking your home’s current market value and subtracting what you owe on your mortgage. The final number is your home equity.

[home’s value] ➖ [mortgage balance] 🟰 [home equity]

You build your home equity every month when you make your mortgage payments. With every home payment you make, you own more of your home.

Home loans range from 10 to 30 years, with recent mortgages stretching up to 40 years. But if you want to use some of the money you’ve paid into your home right now, you can tap into your home equity through a home equity loan or HELOC.

Dig deeper: 4 ways to get equity out of your home

A home equity loan is a type of loan that allows you to borrow against your equity without refinancing. With a home equity loan, you can typically borrow up to 80% of the home’s value, minus what you currently owe. Term rates can be as long as traditional mortgages, so up to 30 years.

With a home equity loan, you receive your money in one lump sum, and you repay what you borrow with a fixed interest rate that doesn’t change for the life of the loan. Because of this, home equity loans often come with lower interest rates than unsecured borrowing options like personal loans or credit cards.

Yet home equity loans are secured loans that use your home as collateral, which means that if you can’t repay your loan, your lender could decide to foreclose on your home.

  • Because rates are fixed, you could miss out if rates fall

  • You’ll need to know how much to borrow when you apply

  • You’ll pay interest on the total borrowed amount, even if you don’t use it all at once

  • You may pay closing costs and other upfront fees

  • If you don’t repay your loan, you could lose your home

Dig deeper: Personal loan vs. home equity loan: Which is the best fit for your financing?

A home equity line of credit — more commonly called a HELOC — is a revolving line of credit that’s similar to a credit card. You can borrow on your credit line when you need it and make payments on your balance to build back up to your credit limit, which is usually 85% of the market value of your home minus what you currently owe.

You can borrow as much or as little as needed up to your limit through your draw period — the first phase of a HELOC, in which you can withdraw money. Draw periods can last up to 10 years, depending on the HELOC.

When your draw period ends, your repayment period begins. Repayment schedules typically last about 20 years after your draw period. You won’t be able to withdraw from your HELOC anymore, but you’ll continue to make payments on your line of credit until it’s paid in full.

HELOCs come with a variable interest rate, which means you could benefit if rates fall. While it fluctuates based on an index, it’s still usually much lower than other types of lines of credit, like a credit card. HELOCs are a secured line of credit, so you could face foreclosure if you can't pay back what you owe on time.

  • Borrow what you need when you need it for years without additional approval

  • Variable rates mean you won't miss out when the Fed cuts the benchmark

  • You pay interest only on the money you borrow

  • Interest rates can be lower than unsecured loans

  • Possible property appraisal, application fee and closing costs

  • Missing payments and falling behind could result in losing your home

Every lender has slightly different qualifications for home equity loans and HELOCs, but you can expect to meet general requirements around your credit score, debt-to-income ratio and level of home equity you’ve built in your home:

  • Credit score of 680 or higher. Generally, the higher your score, the lower your interest rate will be.

  • Debt-to-income ratio of up to 43%. Your DTI is how much debt you have compared to how much you earn. Most lenders want to see a DTI of 43% or less, although some might go as high as 50%.

  • Home equity of at least 15%. You’ll typically need at least 15% to 20% equity in your home to qualify. Remember, it’s not what you paid for your home but rather your home’s worth, so you might already hit the minimum equity requirements.

Some lenders specialize in borrowers who don’t check all of the boxes, so shop around with multiple providers to learn what you’re eligible for.

🔍 How to calculate your debt-to-income ratio

To find your DTI, first add up all of your monthly debt — your housing expenses, credit card repayments and loan repayments among them. Divide your total debt by your gross monthly income, and then multiply that number by 100. This figure is your DTI.

[monthly expenses] ✖️ [gross monthly income] ✖️ 100 🟰 DTI%

Home equity loans and HELOCs are good options for homeowners who need to borrow money but would rather borrow against what they’ve already paid into their homes. These loans are among the most cost-effective ways to borrow money, offering some of the lowest interest rates around compared to unsecured loans.

You might want a home equity loan if:

  • You know how much you need to borrow

  • You want a fixed interest rate with predictable payments

  • You can afford monthly payments

You may want a HELOC if:

  • You don’t want a lump-sum amount

  • You want the option to withdraw funds when you need them

  • You don’t mind a variable interest rate

While home equity loans and HELOCs are one way to get some of your home’s equity back into your pocket, they aren’t the only way. Look to these alternatives for funding your next project or paying down high-interest debt:

  • Cash-out refinance. This type of secured loan replaces your current mortgage with a new, bigger loan with new terms and a new mortgage rate. You’ll pocket the difference between the two loans as cash, repaying the new loan over terms as long as 30 years. A cash-out refinance can be expensive, requiring a home appraisal and closing costs.

  • Reverse mortgage. A home equity conversion mortgage is a special type of loan for homeowners ages 62 and older who own their homes outright or are close to paying them off. More commonly called a reverse mortgage, it pays you either a lump sum, monthly payments or a combination of the two from your home equity, and the loan is paid back with interest and fees after you die or no longer live in the home.

  • Personal line of credit. This type of loan is like a HELOC, only it’s not secured by your home — which means you won’t face foreclosure if you fall behind on repayments. Personal lines of credit tend to have higher interest rates but with no restrictions on how you can use them.

  • Personal loan. A personal loan is a fixed-interest loan that pays out a lump sum you can use for any purpose. You repay what you borrow with interest and fees, with loan amounts, rates and terms that depend on factors like your creditworthiness or DTI, and not the value of a personal asset, like a home. Rates can be higher than home equity loans, and they aren’t ideal for projects with unpredictable costs.

  • 0% APR credit cards. If you have good to excellent credit you might qualify for a credit card offering a no-interest period of 18 to 21 months, giving you time to purchase what you need and repay what you borrow without interest charges. When shopping around, confirm the intro offer applies to purchases — and make sure to pay off your card in full before the offer expires to avoid hefty interest on any remaining balance.

Dig deeper: Can you use a home equity loan to buy a rental or investment property?

Still have questions about whether it makes sense to tap into your home's value? Learn more about how to use your home equity before taking your next step.

There are no restrictions as to how you can use the money from a home equity loan, which means you might be able to tap into your home equity to finance a rental or investment purchase. But borrowing from your home equity is risky, especially if you don't know whether an investment is a sure thing. Learn more about the risks, benefits and options in our guide to using your home equity to invest in real estate.

Yes. Typical interest rates on home equity loans are lower than those of the average credit card and personal loan, and tapping into your home's value to pay off high-interest debt could significantly lower the interest amount you'll pay on these separate debts. But there's a lot at stake if you aren't able to repay your home equity loan on time, including the potential loss of your home to foreclosure. Make sure any new loan you take on offers enough wiggle room in your budget for emergencies and unexpected expenses. And read our guide to using home equity to pay off high-interest debt.

Some lenders offer interest rate reductions of 0.25% to 0.50% if you sign up for autopay — or automatic payments from a bank account. Call the bank or credit union directly to ask about autopay or any other discounts you might be eligible for.

Dori Zinn is a personal finance journalist with more than a decade of experience covering credit, debt, investing, real estate, student loans, college affordability and personal loans. Her work has been featured in the New York Times, the Wall Street Journal, Yahoo, Forbes and CBS News, among other top publications. She loves helping people learn about money.

Article edited by Kelly Suzan Waggoner

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