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Homeowners have been fortunate in recent years. While credit card and personal loan rates have soared, they’ve enjoyed a much more affordable way to borrow cash: Home equity loans and home equity lines of credit (HELOCs). These products allow homeowners to turn their home equity into liquid funds, which they can use for anything — paying for home repairs, settling medical bills, or even paying off higher-interest debts.
But while both are good options if you need to borrow cash, borrowing $50,000 on a home equity loan versus $50,000 on a HELOC isn’t exactly the same. Want to know which one you should choose for your money needs? We asked some experts to weigh in.
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How is a $50,000 home equity loan different from a $50,000 HELOC?
Both HELOCs and home equity loans turn your home equity into cash, but that’s done differently for each. With home equity loans, you’ll get a lump sum after closing, so if your home equity loan were for $50,000, you’d get that money all at once.
This can be smart if you need a lot of cash right now — maybe for a large expense or medical bill. If, however, you need money over an extended period (for college tuition or an ongoing renovation project, for instance), a HELOC is likely a better bet.
“The key difference is that a HELOC functions like a credit card, meaning it has a revolving credit line,” says Dre Torres, a loan officer at Cornerstone First Mortgage and founder of The Mortgage Coach LLC. “You can borrow as needed during the draw period.”
This means you’d have $50,000 at your fingertips for 10 years in most cases. Withdraw from it when you need it, and use it for a variety of expenses over time. Or you can just keep it for emergencies. You don’t technically have to spend any of it.
“If you have ongoing or uncertain expenses, it’s a good option,” Torres says. “You get approved for that line and can pull from it as you need it. It gives you flexibility.”
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Understand how the interest will work
Interest works differently on home equity loans and HELOCs, too. First, home equity loans tend to have fixed interest rates, but HELOCs will adjust over time thanks to a variable rate.
“HELOC rates are usually variable and tied to the prime rate, plus a margin — anywhere from zero to 4%,” says Debra Shultz, vice president of lending at CrossCountry Mortgage. “The prime rate tracks the federal funds rate, so as the Federal Reserve raises and lowers the federal funds rate, the prime rate follows by the same amount.”
But there’s more to consider. On home equity loans, you’ll pay interest on the full approved amount from the start. On a HELOC, you’ll only pay interest on what you withdraw from your line of credit.
“HELOCs may only require you to pay the amount of interest owed during the initial draw period,” says Scott Bridges, chief consumer direct lending production officer at Pennymac. But, “you can borrow, repay, and borrow again during the agreed upon draw period.”
Know what payments you can afford now — and down the line
Monthly payments function a bit differently between home equity loans and HELOCs. With home equity loans, you’ll start making full principal-and-interest payments in the first month. HELOCs, on the other hand, allow you to make interest-only payments (in most cases) at the start. Then, once you enter the repayment phase (usually 10 years into the credit line), you’ll start paying down the principal.
For this reason, home equity loans are better if you know you can comfortably make a full second mortgage payment right away. HELOCs may be better if you need a lower monthly payment now, but know you’ll have more income in a few years — once those full payments start coming due.
“Oftentimes, the principal-and-interest payment on a home equity loan is more beneficial to somebody on a fixed income,” Torres says. “It makes more sense for them financially to know what their monthly payment will be.”
Whatever you choose, make sure you compare more than just your rates and payments. Look at a few different lenders, and ask about any potential fees, too. “Make sure to be aware of what all the fees are associated with the loan,” Bridges says. “Some HELOCs have annual fees and draw fees.”
