What's the Difference Between a Home Equity Loan and a HELOC?

Owning a home is one of the most important investments a person makes in their life. Not only can you sell your home, hopefully for more than you paid for it, and use the money from the sale to buy a new home, you could also take advantage of your home’s equity while you still live in the home through a home equity loan or a home equity line of credit (HELOC).

People often use home equity loans and HELOCs to cover large expenses like home repairs or renovations or school tuition. Although both home equity loans and HELOCs allow you to take advantage of the equity in your home, it’s important to remember they aren’t the same thing and there are some very significant distinctions between the two.

A home equity loan works very much like any other type of loan. One the loan is approved, the homeowner receives their money in a lump sum. The amount of money you can borrow with a home equity loan is based on the value of your home, minus the outstanding balance of your mortgage. In most cases, banks and credit unions give home equity loans for up to 80% of a home’s value, but some will go higher than that. The homeowner then makes set monthly payments on the loan with interest and the loan is set to be paid off within a specific timeframe. Although these are often called “second mortgages,” home equity loans are intended to be paid off sooner than a traditional mortgage.

With a HELOC, the equity in your home is used as a revolving line of credit rather than a one-time loan. If you have a credit card, you have a good idea of how revolving lines of credit work. You’re authorized to spend up to a certain amount of money, but when you pay off the amount you’ve used, your available line of credit goes back up to its original amount and you can use it again. So let’s say you have a HELOC worth $20,000 and decide to use $5,000 of that to make some home improvements. Once you repay that $5,000, you have $20,000 worth of credit available to use again if you need it.

One advantage that HELOCs offer is that you only have to pay interest when you actually use it. So if you go months without using it, you don’t have to pay any interest on it. But home equity loan payments are easier to predict and plan for than payments for HELOCs are. Home equity loans are paid off in set amounts with a fixed interest rate, so you’ll know exactly how much you’ll have to pay every month. HELOCs, on the other hand, have variable interest rates so the payments on those will depend on both the amount you spent and what the interest rate is at the time.

Whether a home equity loan or a HELOC would be best for you can depend on several factors. If you’re considering one, an employee of your bank or credit union will be able to help you figure out which option would be the best for you.