Heloc vs Home Equity Loan: When Are They a Good Idea? (2024)

For most homeowners, home equity loans and home equity lines of credit (HELOC) are the only viable ways to tap home equity these days.

While a cash-out refinance would traditionally be a wise choice, today’s higher mortgage rates have made that strategy unappealing. About 89% of mortgaged homeowners have a current rate of 6% or below, so refinancing would mean trading a low rate for a much higher one on your entire balance.

Home equity loans and HELOCs are a different story, though, allowing you to keep that low rate on your current loan while borrowing from your home equity at the same time. These loans are a smart option for homeowners in need of cash (especially with the average homeowner now sitting on about $300,000 in equity, according to recent data).

Here’s how these types of loans work—and when you might want to choose one over the other.

How do HELOCs and home equity loans work?

Home-equity loans and HELOCs are tools for borrowing from your home equity, or the portion of your property you actually own.

With a home equity loan, you borrow a lump sum from your equity—typically up to 80% to 90% of your home’s value, minus your mortgage balance. You can then use the cash you receive however you wish, paying it back monthly—plus interest—over the course of 10 to 30 years. These are sometimes called second mortgages, and paying one back will look and feel similar to repaying your original loan.

HELOCs work a little differently. You’re still borrowing from your equity and can use the money as you please, you don’t get the funds you borrow in one lump sum. Instead, a Heloc functions more like a credit card, in that you get access to a line of credit you can pull from as needed.Repayment is different too. With a HELOC, you’ll have a draw period—typically 10 years—during which you can access funds. Throughout this time, you’ll usually only need to make interest payments on the money you pull out. After that, you enter the repayment period. For some Helocs, this means making monthly payments for the next 20 years. For others, you may need to make a balloon payment, repaying the full amount you borrowed at once.

Who can use home equity products?

To use a home equity loan or HELOC, you need to start with a good amount of equity. Lenders generally require that you maintain at least 20% equity in the home after taking out a home equity loan or HELOC. This means that your mortgage balance and your home-equity loan balance—when combined—can’t equal more than 80% of your home’s total value.

For example, if you had no other mortgage, you could borrow up to $320,000 on a home worth $400,000. If you have a $100,000 balance on your first mortgage, you could borrow up to $220,000 with a HELOC or home equity loan.

Aside from having enough equity in your home, you will need to meet other financial requirements. It varies by lender, but you’ll usually need a credit score in the mid-to high-600s and a debt-to-income ratio of 43% or less, meaning your total monthly debt payments—including your new Heloc or home-equity loan payments—must equal 43% of your monthly income or less.

“Generally, a home equity loan or HELOC is great for folks who are working full time, have predictable income, can afford the additional monthly payment and have a credit score above 640,” says Jeff Levinsohn, CEO of equity tracking platform House Numbers. “If you’re paying off higher-interest debt with home equity, that helps you qualify. You’ll erase that monthly debt payment and often free up extra cash each month.”

Who should use a home equity product?

If you have a lot of equity in your home, home equity products can be a smart option if you need a large amount of cash, as other financial products such as credit cards or personal loans tend to have lower loan limits and come with higher rates.

“While personal loans of up to about $50,000 are fairly common, it’s harder to obtain them for larger amounts—and then, they often come with higher interest rates,” says Kyle Enright, president of mortgage at digital finance company Achieve. “With a home equity loan or HELOC—depending on the amount of equity you have in the home—much higher amounts are available.”

Home equity products can also come with a valuable tax write-off, too. If you itemize your deduction and use the funds to “buy, build or substantially improve your house,” according to the IRS, you can deduct the interest you pay on the loan from your taxable income.

Should you get a home equity loan or a HELOC?

Both loan types let you turn the value you’ve built in your home into cash, but the right choice depends on a few factors.

First, do you know exactly how much you need to borrow? If so, a home equity loan could be smart. If you don’t have a solid estimate—or you need access to money over an extended period (for college tuition or a home renovation, for instance)—a Heloc may be the better option, as it will allow you to withdraw money as needed, up to your credit limit.

With a HELOC, you can even pay back what you’ve borrowed and withdraw more later on, as long as you’re still within your draw period. You also only pay interest on what you borrow, allowing you to simply leave the credit line untouched unless you really need it.

The size of payments you’re able to make matters, too. If you need lower payments for the near term—usually the next 10 years—a HELOC may be a better fit, as you’ll typically be required to make interest-only payments for that first phase of the loan. Just remember that once you enter the repayment phase you’ll need to pay both interest and principal and your payments will increase considerably, so be sure you have the funds ready to support that.

Whichever home equity product you choose, make sure you check the fine print to see if your Heloc requires a balloon payment or comes with variable interest rates, as some do, which means your payments could increase over time. As long as you’re prepared for this, though, and you fully understand the terms you’re agreeing to, “A HELOC or home equity loan can be an excellent tool for financial wellness,” says Alex Madonna, an executive at mortgage lender loanDepot.

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More on home loans

• What Is a Home Equity Line of Credit?
• How to Choose a Home Equity Loan
• What Is a Cash-Out Refinance, and How Do You Get the Best Rates?
• How to Pay for a Home Renovation