Home Equity Loans vs. HELOCs: Accessing Your Cash

If you own a home, you might be sitting on a significant amount of untapped wealth. As property values have risen over the past few years, homeowners have gained record amounts of equity. Tapping into that value can help pay for major renovations, consolidate high-interest debt, or cover large unexpected expenses. To get that cash, you generally have two main options to choose from: a home equity loan or a home equity line of credit (HELOC).

What is a Home Equity Loan?

A home equity loan is often called a second mortgage. When you choose this route, a lender gives you the money in one single lump sum. You then pay that amount back over a set timeline, which typically ranges from five to 30 years.

The biggest advantage of a home equity loan is the predictable payment schedule. These loans almost always come with fixed interest rates. Your monthly payment will remain exactly the same from your first bill to your last. This makes budgeting incredibly easy. Lenders like Discover and U.S. Bank frequently offer these loans with fixed rates, making them an attractive option if you know exactly how much money you need right now. For example, if you have a 50,000 dollar roofing project, getting a fixed 50,000 dollar loan guarantees you have the exact funds required to pay the contractor before the work even starts.

What is a Home Equity Line of Credit (HELOC)?

A HELOC operates much more like a traditional credit card. Instead of handing you a pile of cash all at once, the lender approves you for a maximum credit limit. You can borrow against that limit, pay it back, and borrow again as needed.

HELOCs are broken into two specific phases. First is the draw period, which usually lasts 10 years. During this time, you can pull money out, and you are generally only required to make small, interest-only payments on the amount you actually borrow. Once the draw period ends, the repayment period begins. This phase usually lasts 10 to 20 years. At this stage, you can no longer borrow money, and you must pay back both the principal and the interest.

Unlike home equity loans, most HELOCs have variable interest rates. Your rate is usually tied to the prime rate. If the Federal Reserve raises rates, your monthly payment will go up. Major institutions like Bank of America and PNC Bank offer HELOCs, and some even provide introductory rate discounts for the first six months.

Important Differences in Interest Rates and Costs

Interest rates are a critical factor when choosing between these two products. As of early 2024, average home equity loan rates are hovering around 8.5 percent to 9 percent. HELOC rates tend to start slightly higher, often averaging between 9 percent and 10 percent depending on your credit score and the lender.

Because a home equity loan has a fixed rate, lenders often price it slightly higher upfront to protect themselves against future market changes. A HELOC might start with a lower initial rate, especially if the bank offers a promotional rate for the first year, but that rate can climb over time.

Closing costs also differ. Home equity loans often require closing costs similar to a primary mortgage, ranging from 2 percent to 5 percent of the total loan amount. Conversely, many lenders absorb or waive the closing costs on HELOCs, provided you agree to keep the account open for at least three years.

Borrowing Limits and Loan-to-Value Ratios

Lenders will not let you drain 100 percent of the value out of your house. To figure out how much you can borrow, banks look at your combined loan-to-value (CLTV) ratio. This number represents your primary mortgage balance plus your desired new loan, divided by the current appraised value of your home.

Most major lenders cap your combined loan-to-value ratio at 80 percent or 85 percent. Let us look at a specific example. If your home is worth 400,000 dollars, an 80 percent limit equals 320,000 dollars. If you still owe 200,000 dollars on your primary mortgage, your maximum borrowing limit for either a home equity loan or a HELOC would be 120,000 dollars. Some credit unions like Navy Federal Credit Union might allow you to go up to 90 percent or even 100 percent of your equity, but those high-limit loans come with significantly higher interest rates.

Deciding Which Option Fits Your Needs

Choosing the right product comes down to how and when you need to spend the money. A home equity loan is the best choice if you have a massive, one-time expense. If you are building an addition onto your house, paying for a wedding, or consolidating 30,000 dollars in credit card debt, you need all the money upfront. The fixed payments guarantee you will not face payment shock down the road.

A HELOC is ideal for ongoing, unpredictable expenses. If you are doing a multi-stage home renovation over three years, paying college tuition over eight semesters, or just want an emergency safety net, a HELOC makes sense. You only pay interest on the money you actually pull out. If you open a 100,000 dollar HELOC but only spend 15,000 dollars on kitchen cabinets, you only pay interest on that 15,000 dollars.

Frequently Asked Questions

Can I convert my variable-rate HELOC to a fixed-rate loan? Yes, many lenders now offer a fixed-rate conversion option. For example, Citizens Bank and Chase offer features that allow you to lock in a fixed interest rate on all or a portion of your outstanding HELOC balance. There is usually a small fee or a slightly higher rate applied when you choose this option.

Are the interest payments on these loans tax-deductible? Under the Tax Cuts and Jobs Act of 2017, the IRS allows you to deduct interest on a home equity loan or HELOC only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. If you use the money to pay off credit cards or buy a car, the interest is not tax-deductible. Always check with a certified tax professional for your specific situation.

How long does it take to get the funds? Applying for either option is very similar to applying for a standard mortgage. The lender will require income verification, a credit check, and a home appraisal. Because of these requirements, it typically takes between two to six weeks to close on a home equity loan or HELOC and receive your funds.