Is there a downside to getting a HELOC?

Because you have access to a line of credit over a period of a few years, rather than a set amount of money borrowed all at once, a HELOC comes with additional temptation to overspend on unnecessary purchases -- and when the repayment period starts, your payments will be higher than during the draw period.

Can taking out a home equity loan or HELOC hurt your credit score?

The initial hard credit inquiry involved with borrowing against your home will impact your credit score and will likely result in a drop of a few points. But if you make payments on time and in full, your credit score will recover from this. Plus, a home equity loan or HELOC could diversify your credit mix -- this can boost your credit score, and shows lenders you can handle different types of credit. If you miss payments or make them late, however, you could see serious drops in your credit score.

What credit score do you need for a home equity loan?

Many lenders require a credit score of at least 680 to be approved for a home equity loan. Other factors matter too, though, including your debt-to-income ratio.

Home Equity Loan vs. HELOC: Which is Right For You?

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If you're considering borrowing against your home equity, you need to understand the differences between a home equity loan and a HELOC.

A home equity loan and a home equity line of credit (HELOC) both allow you to tap into your equity. But they differ in how you borrow money and how your interest rate works.

This guide will help you understand the home equity loan vs. HELOC basics so you can decide which is right for you.

An overview of home equity loans and HELOCs

Let's break down how both work before we look at the similarities and differences.

How a home equity loan works

When you take out a home equity loan (or second mortgage), the lender appraises your home to determine how much you can borrow. Your qualifications, including income and credit score, will also be evaluated. These help determine the interest rate as well as the loan amount.

Once you've been approved, you'll be given the entire amount upfront in a lump sum. You'll pay these funds back on a fixed schedule over the loan term. Your monthly payment will be based on the amount borrowed, term length, and interest rate.

If you take out a fixed-rate loan, you'll have predictable payments. You'll know exactly what your interest rate and payments will be for the entire duration of the loan -- they won't change while you're paying the loan back.

How a home equity line of credit works

A home equity line of credit (HELOC) allows you to borrow against your home’s equity with a flexible credit line, similar to a credit card. The lender determines the size of your credit line based on your home’s value, and during the "draw period," you can borrow as much or as little as you need up to the limit. As you repay what you've borrowed, the funds become available again for use.

For example, with a $15,000 line of credit, you could borrow $5,000 now, another $2,000 later, and once repaid, you can borrow that amount again during the draw period.

HELOCs typically come with a variable interest rate, meaning your payments may fluctuate based on changes in interest rates. During the draw period, you might only need to pay interest on the amount borrowed, but once the repayment period begins, you'll pay both principal and interest, which results in higher payments but a faster payoff. Access to the credit line can be through a card or checks, though some lenders may have minimum borrowing requirements. At the end of the draw period, the full loan amount must be repaid on a set schedule.

Home equity loan vs. HELOC: Key similarities

Home equity loans and HELOCs share some important characteristics. Below, we'll cover some of the ways in which these two types of loans are similar.

Qualification requirements

Both home equity loans and lines of credit allow you to borrow against the value of your property. However, you can only borrow this way if you have equity in your home.

Equity is the value of your mortgaged property minus what you owe on the home. If you have a home valued at $300,000, and you owe $200,000 on your mortgage loan, you have $100,000 in equity.

Lenders will want to appraise your home to determine its value. They'll typically cap the amount you can borrow so you don't owe more than 85% to 90% of your home's value (including your existing mortgage debt and new loan). Both types of loans also require you to qualify based on your income and credit score.

Interest rates

When you take out either a home equity loan or a HELOC, the interest rates for these can be lower than the rates on a personal loan or credit card.

Additionally, for both types of loans, your interest may be tax deductible. You're permitted to deduct interest paid on a home equity loan or line of credit if you use the proceeds of the loan to cover costs of buying, building, or improving the home you're borrowing against. The home must be your primary or second home in order for you to be eligible for this tax deduction.

Risks

Unfortunately, there's a risk to both types of loans. First, you face the possibility of foreclosure if you can't pay. This is because your home equity loan or HELOC loan is secured debt.

In both cases, your house is the collateral -- which means if you don't pay, the lender can foreclose on your home. It's also possible that if you take too much equity out of your home, you'll end up owing more than the house is worth (also known as being underwater on your mortgage).

If you need to sell your home, you'd have to pay the outstanding balance, which is the difference between what your home sells for and what you owe.

Home equity loan vs. HELOC: Key differences

Although there are similarities between home equity loans and HELOCs, there are also important differences. You need to understand the discrepancies between a home equity loan vs. HELOC to make the smartest choice for your situation.

The biggest difference is in the way money is lent to you. When you take out a home equity loan, you borrow a fixed amount of money for a designated period of time. You might borrow $20,000 for five years with a home equity loan.

A home equity line of credit, on the other hand, doesn't involve borrowing a set amount. Instead, you'll be approved to borrow up to a certain amount of money that you can draw from over time.

Home Equity Loan	HELOC
You borrow a set amount	You borrow up to a certain amount (like a credit card); as you pay it back, you can draw from your credit line again
You have a set repayment schedule and know total costs	Often don't have predictable costs or payoff schedules
Fixed-rate loans are available	Most are variable-rate loans (some lenders offer fixed-rate loans)

Which is right for you?

There's a lot to consider when deciding between a home equity loan vs. HELOC.

If you know how much you want to borrow and need the money upfront, a home equity loan is usually the best choice. When you borrow via one of the best home equity loan lenders, you'll have the certainty of knowing how much your payments will be.

But if you want to have a line of credit available that you can draw from as needed over time, a home equity line of credit is the right financial product.

Ultimately, you need to consider your situation and goals when deciding between a home equity loan vs. HELOC. Regardless of which you choose, borrow responsibly: You're borrowing against your home's equity. And make sure to shop around among the best mortgage lenders to find the most affordable loan options.

Still have questions?

Here are some other questions we've answered:

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FAQs

Because you have access to a line of credit over a period of a few years, rather than a set amount of money borrowed all at once, a HELOC comes with additional temptation to overspend on unnecessary purchases -- and when the repayment period starts, your payments will be higher than during the draw period.
The initial hard credit inquiry involved with borrowing against your home will impact your credit score and will likely result in a drop of a few points. But if you make payments on time and in full, your credit score will recover from this. Plus, a home equity loan or HELOC could diversify your credit mix -- this can boost your credit score, and shows lenders you can handle different types of credit. If you miss payments or make them late, however, you could see serious drops in your credit score.
Many lenders require a credit score of at least 680 to be approved for a home equity loan. Other factors matter too, though, including your debt-to-income ratio.

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Home Equity Loan vs. HELOC