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

What Is a Home Equity Line of Credit (HELOC)?

Home equity lines of credit are structured in different ways. When borrowing with a HELOC from Freedom Mortgage, you get a lump sum up front at a fixed rate, and you pay principal and interest immediately. As you pay down your balance, you can redraw funds without going through a new loan approval process. The rate on your redrawn funds is determined at the time you borrow.

A lender may offer a home equity line of credit (HELOC) which allows you to borrow up to a set amount, but you don't get a lump sum payment all at once. Instead, the loan works like a revolving line of credit you can draw from as needed. It usually has a variable interest rate, and often requires only interest-only payments during the draw period. The remaining principle balance is repaid during the repayment period.

The flexibility to borrow again as needed makes HELOCs a good option for many who want to access credit when they need it.

Pros and Cons of HELOCs

The table below shows the pros and cons of HELOCs.

What Is a Home Equity Loan?

When you take out a home equity loan, you receive a lump sum and repay it through fixed monthly payments over a set term. The amount you can borrow is based on the equity you have, and interest rates are usually fixed so your payment stays the same for the life of the loan.

You cannot redraw or borrow again once you have taken out a home equity loan.

Pros and Cons of Home Equity Loans

The table below shows the pros and cons of home equity loans.

Home Equity Loan vs. HELOC Requirements

You need to know the home equity loan and HELOC requirements before you move forward with borrowing.

Typically those requirements include:

• Good credit: Lenders want to see that you have been responsible with paying your bills in the past. Specific credit score requirements can vary.
• Equity in your home: You will need to have enough equity to borrow. Typically, your combined loan-to-value ratio must be within the lender's set maximum, commonly in the 80%–85% range. Combined loan-to-value ratio is the total amount of all loans against equity (including your first mortgage and the new loan), relative to the value of the home.
• Stable income: You'll need proof of stable income to show your lender that you have the funds to pay back what you borrow.
• An acceptable debt-to-income ratio: Lenders may allow debt-to-income ratios up to 50% but you may want to stay around 40% of your income to keep your total debt payments affordable.

Taking steps to improve your credit and pay down debt can help you become a well-qualified borrower.

How to Choose Between a HELOC and a Home Equity Loan

The right way to get equity out of your home depends on your specific situation, budget, risk tolerance, and long-term financial goals Here are the factors to think about as you make your decision.

When a HELOC May Make Sense

A HELOC may be a good idea if:

• You have ongoing home improvement projects.
• You want to borrow for an emergency or unexpected expense today and be able to borrow again if you face surprise costs in the future.
• You want to pay off some higher interest debt now, and be able to access affordable lower interest debt as needed after paying off the initial amount you borrow.

If flexibility is important to you, applying for a HELOC is your best bet.

When a Home Equity Loan May Make Sense

A home equity loan could be a good borrowing choice if:

• You are doing a major home renovation, making a major purchase, or paying a bill with a known cost.
• You want a one-time loan to pay off higher interest debt and don't expect to need to borrow again in the future.
• You have a one-time expense to pay for and don't expect to need the flexibility to redraw funds as needed.

If you want fixed payments and knowing your borrowing costs up front is important to you, choosing a home equity loan makes sense.

HELOC vs. Home Equity Loan FAQs

Still need to know more? Here are the answers to some frequently asked questions about HELOCs versus home equity loans.

Which Is Better, a HELOC or a Home Equity Loan?

A HELOC can be a better choice if you need the option to borrow after you take out your initial loan. A home equity loan can be a better option if you only need to borrow one time for a single expense.

Is It Easier to Qualify for a HELOC or a Home Equity Loan?

The process of qualifying for a HELOC versus a home equity loan is very similar. You will need to have good credit and proof of income, as well as equity in your home.

Can You Have Both a HELOC and a Home Equity Loan?

Not usually, but in some cases it might be possible to have both a HELOC and a home equity loan. However, your combined loan-to-value ratio typically must stay within the lender's set maximum, commonly in the 80%–85% range. This would mean your first mortgage, home equity loan, and home equity line of credit would all have to total within that limit of what your home is worth.

Final Thoughts: Is a HELOC or a Home Equity Loan Best for You?

Whenever you are tapping into the equity in your home, it's important to consider the pros and cons. Freedom Mortgage can help you understand borrowing options and find the loan that's right for you. Reach out today to get prequalified or schedule a chat with a mortgage loan professional to learn more.