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When purchasing a home, equity is a valuable financial tool that can be used to help you finance big purchases. When trying to access the funds that your home’s equity can secure, both home equity lines of credit (HELOCs) and home equity loans are popular options.
Both HELOCs and home equity loans use your home as collateral, which means that the interest rates that you could receive are often better than through a personal loan or on a credit card. Depending on the amount of equity you have in your home, these home equity products often offer higher borrowing limits that financing options like credit cards or personal loans.
A HELOC is a line of credit that charges interest with a variable interest rate while a home equity loan is a fixed amount (one lump sum) featuring a fixed interest rate. Selecting the appropriate type of borrowing is based on your specific needs.
While a home equity loan’s fixed rate creates fixed monthly payments over the life of a loan, a HELOC’s monthly payments may fluctuate based both on the amount you choose to borrow and if and how much a HELOC’s variable rate moves.
A HELOC also includes two separate periods: a withdrawal period and repayment period. During the withdrawal period (which often lasts up to 10 years), many HELOC lenders allow you to pay only interest against the amount you withdraw from your line of credit. Once the withdrawal period ends, the repayment period (ranging from five to 20 years) starts, where both the principal and any remaining interest will be repaid.
When choosing any form of a loan, the interest rate is a key factor in selecting the right loan for you to keep interest charges low. Home equity loans feature fixed interest rates, while a HELOC traditionally has variable interest rates. Both HELOC and home equity loan rates will depend on the amount you borrow, the amount of equity available in your home, your income and debt, your credit history, and market conditions.
For home equity loans, this means you will be making the same (or very similar) repayments towards both the loan’s principal and any interest every month. This stability can be attractive to borrowers, but home equity loan interest rates may start a bit higher than a comparable HELOC interest rate.
HELOC interest rates are typically variable rates that can change over the life of the loan. Variable rates depend on the Federal Reserve’s benchmark prime rate. In strong economic times, the Fed rate will be relatively low, which translates to lower variable rates. If the economy dips and the Fed moves interest rates up, variable rates will move with it. The ups and downs of the economy could impact HELOC variable rates over the life of the repayment period, which can directly impact how much you have to repay each month.
Some HELOC lenders even offer an option to convert your HELOC borrowing to a fixed-rate loan, where you can combine the flexible borrowing of a HELOC with the fixed rates of a typical home equity loan.
While there are some basic differences between HELOCs and home equity loans, both offer the benefits of competitive rates when borrowing. If you put your funds towards home improvements, you may also qualify for tax deductions for any interest you pay towards the loan or line of credit – whether you use a HELOC or a home equity loan.
Borrowers that don’t know their final expense may enjoy the flexible line of a credit with a HELOC, while borrowers that have a final cost in mind may want to opt for the straightforward lump sum borrowing of a home equity loan. If interest rates are a concern, you can opt for a usually higher starting rate with a home equity loan for the sake of stable monthly payments, or you can opt for the variable HELOC rates, which give you the potential of lower rates as the Fed rate moves down or the risk of higher rates if it moves the other way.
