Home Equity Loan vs HELOC: What’s the Difference?

When you buy a home, you invest in privacy, stability and a space that you can call your own as you make new memories with loved ones. But did you know that your investment could also pay off in other ways? The equity you build in your home could help you access funds to cover life’s major milestones, like your child’s college education or renovations to make your home more accessible as you age.

Two common ways to tap into your home’s equity are a home equity loan and a home equity line of credit (HELOC). Both borrowing options allow you to take advantage of the equity you’ve built in your home without selling it, but you’ll need to know some important details first.

What is home equity?

Home equity is the difference between your home’s market value — how much money you could sell it for today — and how much you still owe on your mortgage.¹ As you make mortgage payments, and if your home’s value increases due to changes in the real estate market, your equity grows.

Some lenders may allow you to borrow money against your home’s equity either in the form of a home equity loan or a HELOC.²

What is a home equity loan?

A home equity loan is an installment loan — a type of loan that pays out a lump sum of money that you repay with interest over a set term in fixed monthly payments.^3,4 A home equity loan is a secured loan, meaning it’s backed with something of value, like your home, called collateral, in order to obtain the loan. If you’re unable to make the required monthly payments, the lender has the right to foreclose on your home to recover the debt.

Lenders typically issue home equity loans for up to 85% of your total equity.⁵ (You can use an online real estate tool to estimate your equity, but the lender will perform a formal appraisal to determine the home value.)

Most home equity loans have a traditional repayment structure, where each monthly payment goes toward both the principal (original amount borrowed) and interest (cost of borrowing). However, some lenders offer interest-only home equity loans, meaning that your monthly payments will apply only to the interest until the end of the loan term. At that point, you’re responsible for paying a large lump sum, called a balloon payment, which includes any remaining interest and the initial amount you borrowed.^6,7

Costs and fees

Some of the fees you might pay when you take out a home equity loan include:⁸

• Origination fee: A one-time fee for processing the application and setting up the loan.
• Appraisal fees: The cost of evaluating your home’s value to determine your borrowing amount.
• Credit report fee: Covers the cost of pulling your credit report, which requires a hard credit check, as part of the lender’s review process.
• Legal fees: May apply if an attorney is involved in reviewing or preparing the loan documents; in some states, this is mandated by law.
• Title search fee: Covers researching public records to confirm the legal ownership of the home and check for liens or disputes.
• Title insurance fee: May be required to protect the lender against claims of ownership disputes, unpaid liens (legal claims against the property) or other title issues — especially if you didn’t purchase coverage with your original mortgage.

Common uses

Because home equity loans provide a large amount of funds at once, many people choose to use the funds to cover large expenses, including:⁹

• A child’s college tuition
• Major home renovations
• Starting a small business
• Wedding expenses
• Debt consolidation

Risks

If you can’t repay your loan as agreed, you could potentially lose your house.

What is a home equity line of credit (HELOC)?

A HELOC is like a home equity loan in that it allows you to borrow funds against the equity in your home. Instead of a lump sum, you’ll take out a line of credit with a set borrowing amount and can take out money as needed, up to that limit, over a period of time known as the draw period.

The draw period

The draw period is the first phase of a HELOC and typically lasts 10-15 years.¹⁰ During the draw period, you can withdraw money up to your credit limit. You can typically access the funds with a bank card, online transfer or paper checks.¹¹

During the draw period, you’ll only pay the interest on the amount you withdraw. For example, if you only draw $20,000, your interest payments will be based on that $20,000 — not the full $50,000 line of credit you were approved for. You’ll start paying back the balance, which becomes the principal amount, and any remaining interest during the repayment period. If you want to get a head start on repaying the principal, you may be able to pay more each month. Be sure to check with your lender to see if you’ll owe a prepayment penalty (a fee for paying off a loan early).¹²

When you pay off some of what you owe, your available credit increases, freeing that money up for you to borrow again.

The repayment period

Once the draw period ends, your HELOC enters the repayment period. During the repayment period, you can no longer withdraw funds. Your monthly payments will increase in the repayment period because you’re paying back the principal and interest rather than just the interest. How much you owe each month will depend on how much of the credit line you use, your interest rate and the length of your repayment term. The length of the repayment period can vary by lender but may last up to 20 years.¹³

Costs and fees

Some of the costs associated with taking out a HELOC include:¹⁴

• Annual fee: A recurring fee you may pay each year to keep your HELOC open, even if you don’t use it.
• Cancellation (or early closure) fee: Charged if you close your HELOC early — typically within the first two or three years.
• Conversion fee: May apply if you switch part of your HELOC balance from a variable interest rate to a fixed rate. A variable interest rate changes according to the terms of your agreement, while a fixed interest rate stays the same.
• Transaction fee: A small fee some lenders charge each time you draw from your credit line — like an ATM surcharge.
• Inactivity fee: Some lenders charge an inactivity fee if you don’t use your HELOC for a long period of time.

Additionally, because most HELOCs have variable interest rates, your payments might be higher or lower from month to month.¹⁵ It’s important to budget for these possible changes and extra costs so you’re prepared for what you might owe each month.

Some lenders also charge a prepayment penalty for paying off a HELOC ahead of schedule.¹⁶

Common uses

Since HELOC funds are available on an as-needed basis, they’re typically ideal for projects that may have shifting costs, such as a home improvement or repair.

You could also use your HELOC to:¹⁷

• Consolidate debt
• Pay for education or caregiving costs
• Cover an emergency expense

While you can use HELOC funds for other expenses, it’s usually best to avoid borrowing more money for non-essential purchases when your home is used as collateral.

Risks

A HELOC is also a secured loan, so it’s crucial to have a solid plan to repay what you owe. If you aren’t able to repay what you borrow, the lender could take ownership of your home. Also, if the interest rates go up, your monthly payments could increase.

Home equity loan vs. HELOC

A home equity loan provides you with a lump sum upfront, making it a good fit for big, one-time expenses. A HELOC, on the other hand, lets you borrow money as you need it, up to a certain limit. The flexibility of a HELOC may make it more useful than a home equity loan for unpredictable expenses. However, HELOC payments may fluctuate in the repayment period if you have a variable interest rate.

HELOCS and home equity loans also have different types of fees, which you’ll need to understand before deciding whether you can afford either borrowing option. Both borrowing options are secured by your home. If you don’t make your payments, you could lose your house.

	Home Equity Loan	Home Equity Line of Credit (HELOC)
Receiving funds	Funds are provided as a single lump sum at closing	Funds can be borrowed as needed, up to a set limit, during the draw period
Repayment	Regular monthly payments over a fixed term	Payments may vary, often interest-only during the draw period, then principal plus interest during the repayment period
Interest rate	Usually fixed, so payments stay the same	Usually variable, so payments can change over time
Common uses	Often used for one-time, large expenses	Often used for ongoing or unpredictable expenses
Access to funds	No further access to funds after receiving lump sum	Ongoing access to funds during the draw period
Fees and costs	May include origination and closing costs such as appraisal fees, title search fees, legal fees and more	May include annual fees, transaction fees, and possible early closure fees
Risks	Home is collateral; non-payment could lead to foreclosure	Home is collateral; non-payment could lead to foreclosure

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Borrow wisely to reach your goals

Whether you’re looking for help to pay for a major life milestone or just want flexibility for potential future expenses, knowing the difference between a home equity loan and a HELOC could help you make a more informed decision. Just keep in mind that both options could lead to foreclosure if you aren’t able to repay what you borrow.

Where possible, think about whether other options, like a personal loan from OneMain or a traditional line of credit, could help you achieve your goals with less risk. Most importantly, don’t hesitate to seek guidance from a trusted financial advisor as you consider which path best supports your long-term goals.

Sources:

1 https://mycreditunion.gov/manage-your-money/home-ownership/home-equity-loans-and-lines-credit
2 https://www.bankrate.com/home-equity/what-is-home-equity/#how-to-use
3 https://consumer.ftc.gov/articles/home-equity-loans-and-home-equity-lines-credit
4,6,7 https://www.investopedia.com/terms/h/homeequityloan.asp
5 https://www.investopedia.com/home-equity-loan-maximum-5323470
8 https://www.bankrate.com/home-equity/home-equity-loan-closing-costs/#home-equity-costs-and-fees
9 https://www.equifax.com/personal/education/loans/articles/-/learn/what-is-a-home-equity-loan/
10,12,13,15 https://www.bankrate.com/home-equity/heloc-refinance-draw-period-ends/#repayment-period
11 https://www.rocketmortgage.com/learn/how-much-heloc-can-i-get
14 14 https://www.consumerfinance.gov/ask-cfpb/what-fees-can-my-lender-charge-if-i-take-out-a-heloc-en-249/
16 https://www.bankrate.com/home-equity/heloc-prepayment-penalty/
17 https://www.bankrate.com/home-equity/best-uses-for-a-home-equity-line-of-credit-heloc/#when-not-to-use