HELOC vs. Home Equity Loan: Which One Is Right for Your Situation?
If you own a home and have built up equity, you have access to one of the cheapest forms of borrowing available: loans secured by your home's value. Both HELOCs and home equity loans let you tap into that equity, but they work very differently.
What Is Home Equity?
Home equity is the difference between your home's current market value and what you owe on your mortgage.
If your home is worth $400,000 and you owe $200,000, your equity is $200,000. Most lenders let you borrow up to 80-85% of your home's value combined (first mortgage + HELOC/home equity loan). With 50% existing equity, you might be able to access $120,000-$140,000.
Home Equity Loan: The Basics
A home equity loan is sometimes called a "second mortgage." You borrow a lump sum at a fixed interest rate and repay it in equal monthly payments over a set term (typically 5-30 years).
How it works:
- You receive the full amount upfront
- Fixed monthly payment for the life of the loan
- Fixed interest rate — your payment never changes
Best for:
- One-time, large expenses with a known cost (kitchen renovation, debt consolidation at a fixed amount, buying another property)
- When you want predictability in payments
- When interest rates are expected to rise (you lock in today's rate)
Typical rates: Usually 0.5-1% higher than HELOC rates (you pay for the certainty of a fixed rate).
HELOC: The Basics
A Home Equity Line of Credit (HELOC) is revolving credit — more like a credit card than a traditional loan. You're approved for a maximum credit limit and can borrow as much or as little as you need during the "draw period."
How it works:
- Approved for a credit limit (say, $80,000)
- Draw period (usually 10 years): borrow what you need, repay it, borrow again. Minimum payments are often interest-only.
- Repayment period (usually 20 years): can no longer draw. Repay principal + interest.
- Variable interest rate tied to prime rate
Best for:
- Ongoing expenses with unknown total cost (multi-phase renovations, college tuition spread over years)
- When you want flexibility to borrow incrementally
- When you might not use the full amount (you only pay interest on what you draw)
- Emergency fund backup (though keeping a HELOC as an "emergency credit line" is risky — see below)
Typical rates: Usually prime rate + 0.5-2%. Prime is currently high; check current rates.
Side-by-Side Comparison
| Feature | Home Equity Loan | HELOC |
|---|---|---|
| Disbursement | Lump sum | Draw as needed |
| Interest rate | Fixed | Variable |
| Payment type | Fixed P&I | Variable (often interest-only during draw) |
| Best for | Known expenses | Ongoing/uncertain expenses |
| Rate risk | None (locked in) | Rate increases possible |
| Flexibility | Low | High |
| Closing costs | Yes (typically 2-5%) | Yes, but often less |
The Variable Rate Risk in HELOCs
Between 2022 and 2024, the Fed raised rates aggressively. A HELOC that cost 4% in 2021 cost 8-9% by 2023. Monthly payments on variable-rate debt can increase significantly.
If you opened a HELOC expecting low rates to last and then saw rates nearly double, your payment for the same balance went up roughly 50%. Plan for rate increases when using a HELOC.
Cash-Out Refinance: A Third Option
A cash-out refinance replaces your existing mortgage with a new, larger mortgage and gives you the difference in cash.
Example: Your home is worth $400,000. You owe $200,000. You refinance to $280,000 and receive $80,000 cash.
Pros:
- Single loan (replaces your mortgage, not a second one)
- Potentially lower rate than home equity loan or HELOC (depends on current rates)
- One payment instead of two
Cons:
- You're restarting your mortgage (resetting the amortization clock)
- If current rates are higher than your existing mortgage rate, you're giving up a lower rate on your entire mortgage balance
- Higher closing costs (refinancing a full mortgage vs. opening a second lien)
In a low-rate environment (when your existing mortgage rate is already low), a cash-out refi often makes sense. When rates are higher than your existing mortgage, home equity loans or HELOCs typically beat cash-out refinancing.
Tax Deductibility
The Tax Cuts and Jobs Act (2017) changed the rules:
Currently: Interest on home equity loans and HELOCs is only deductible if the funds are used to "buy, build, or substantially improve" the home securing the loan.
Using a HELOC to renovate your kitchen: likely deductible. Using a HELOC for debt consolidation or a vacation: not deductible.
Consult a tax professional for your specific situation.
When NOT to Use Home Equity
Home equity loans and HELOCs are secured by your home. If you default, you can lose your house. This makes them inappropriate for:
High-risk business ventures: If the business fails, you could lose your home.
Consumer debt consolidation without behavior change: Consolidating credit card debt into a HELOC at a lower rate is mathematically smart — but many people run the cards back up. Now you have the same card debt plus a home equity loan. The behavior has to change, not just the interest rate.
Ongoing expenses: If you're taking money out of your home to cover living expenses because your income doesn't cover them, you're borrowing against your largest asset to fund consumption. This is a sign of a deeper financial problem.
Luxury purchases: Financing a vacation or luxury car with home equity because rates are lower is a rationalization — you're putting your home at risk for discretionary spending.
How to Access Home Equity
Check your equity position: Get a rough market value estimate from Zillow/Redfin or a CMA from a local real estate agent. Subtract your mortgage balance.
Shop lenders: Banks, credit unions, and mortgage companies all offer these products. Rates vary significantly — compare at least 3.
Calculate CLTV: Combined Loan-To-Value = (existing mortgage + new loan) ÷ home value. Most lenders cap at 80-85%.
Prepare documentation: Pay stubs or tax returns (income verification), bank statements, property information.
Closing: Home equity loans and HELOCs typically close in 2-4 weeks. Expect 2-5% in closing costs, though some lenders waive these.
Home equity is a powerful financial tool when used carefully. The cheap cost of borrowing is real — but so is the risk attached to your home.