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HELOC Vs. Home Equity Loan: Which Is Best For You?

May 07, 2024 6-minute read

Author: Miranda Crace

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As a current homeowner, you may want to undertake a home renovation project or you might need cash for another financial goal. You may be hesitant to do a cash-out refinance, which is a refinance where you trade in your old mortgage for a new mortgage and receive cash back.

Luckily, you have options. Both home equity loans and home equity lines of credit (HELOCs) can help you get the money you need.

Let's take a look at a home equity loan versus a HELOC and discuss the pros, cons, similarities and differences to help you decide which makes better sense for you. Rocket Mortgage doesn't offer HELOCs at this time, but we do offer a home equity loan.

Home Equity Loan Vs. HELOC: What Are They?

The main difference between a home equity loan1 and a HELOC is that in a home equity loan, you get an upfront lump sum that you repay in fixed payments, whereas a HELOC lets you tap into equity as needed up to a certain limit.

HELOCs typically have a variable interest rate (one that changes) versus fixed rates, which are typical in a home equity loan.

Home Equity Loan

Home equity loans are a second mortgage that allow you to use the equity in your home as collateral to borrow money. Collateral means that you use your home as security to protect the lender if you end up defaulting on your loan. Your lender loans money to you as a lump sum at a fixed interest rate, and you make your monthly payments during a repayment period.

You can generally borrow around 80% to 85% of the value of your home, minus what you owe on your mortgage. Rocket Mortgage’s home equity loan option allows you to access $45,000 – $350,000 of your home’s equity in 10- or 20-year term, fixed-rate loans.

Home Equity Line Of Credit (HELOC)

A HELOC is a type of second mortgage that allows you to borrow money against the equity in your home as a line of credit. You can use the equity in your home to pay for whatever you need, such as home improvements, education and consolidating credit card debt.

There are two phases: the draw period and the repayment period. The draw period means that your line of credit is open and available for you to use. During the draw period, the only payments you are required to make are interest payments on any money borrowed.

Once you reach the end of your draw period, you'll have to make repayments based on your principal and remaining interest. Most HELOCs have variable interest rates, which means that they fluctuate based on the changes in the market.

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Pros And Cons Of HELOCs Vs. Home Equity Loans At A Glance

Let's take a look at the pros and cons of HELOCs and home equity loans.

HELOCs

Pros

Cons

Don’t pay unless you use the money

Like credit cards, easy to spend more than planned

Lower initial rate, then variable

Variable rates on HELOCs can make debt grow rapidly

Easier and less costly to get

Can lose your home if you don’t repay

Home Equity Loans

Pros

Cons

Fixed rate

Repayment begins immediately

Installment loan

Higher closing costs than a HELOC

Lower closing costs than a refinance

Can lose your home if you don’t repay

Home Equity Loan Vs. Line Of Credit: Similarities

Let's take a quick look at the similarities of home equity loans and lines of credit.

Both Are Secured Loans

Both types of loans, home equity loans and HELOCs, are secured loans, but what are the differences between secured and unsecured loans?

  • Secured loans: Backed by collateral, secured loans can result in the loss of your home in the case of foreclosure.
  • Unsecured loans: These types of loans don't require collateral. In other words, your lender can’t take away your home if you have an unsecured loan. It's a higher risk to lenders and in exchange, can also carry a higher interest rate. A good example of an unsecured loan is a personal loan, which doesn't require collateral.

Both Come With Closing Costs

Both of these loans are types of mortgage loans that come with closing costs. Closing costs are the charges to pay your lender when you close on a loan. You can expect to pay between 3% – 6% of the loan amount in closing costs, depending on your lender.

The closing costs on a HELOC or home equity loan will likely look similar to those you’d pay on a regular mortgage loan. Some of the common costs include an origination fee, an appraisal fee, a credit report fee, a title search fee and other similar fees.

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Home Equity Line Of Credit Vs. Loan: Differences

Let's also take a look at the differences between a HELOC and a home equity loan.

Fixed Vs. Variable Rate Loans

There are two different types of interest structures among HELOCs and home equity loans.

  • Fixed interest rate: A fixed interest rate doesn't change during repayment. For example, if you have a 5% interest rate, in repayment, you'll pay that same interest until the loan is paid off. A home equity loan almost always keeps the same interest rate.
  • Variable interest rate: A variable interest rate is an interest rate that fluctuates based on an underlying benchmark index or interest rate. A HELOC usually has a variable interest rate.

Installment Vs. Revolving Debt

What is an installment loan? It is a type of loan that you repay over time with regularly scheduled payments – in installments. A home equity loan is an example of an installment loan.

Revolving debt, on the other hand, is open-ended, which means that if you don’t pay the balance on your revolving credit account in full every month, the unpaid portion carries over into the next month. This is called a revolving balance. Some revolving credit accounts include credit cards, a personal line of credit and a HELOC.

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How To Obtain A Home Equity Loan Or Line Of Credit

Let's take a look at the process of getting a home equity loan and securing a line of credit, from the application process, credit requirements, closing costs and appraisal requirements.

Ensure You Meet The Requirements

In order to get a HELOC or home equity loan, your lender will take a look at your equity, credit score and debt-to-income ratio (DTI).

  • Equity: Home equity refers to the portion of your home that you actually own – the difference between what your home is worth and the amount you still owe your lender. For both a home equity loan or HELOC, most lenders will require that you have at least 20% equity in your home. However, some lenders will accept 15%.
  • Credit score: For a home equity loan, you’ll want to shoot for a credit score of 620 or higher. For a HELOC, you can also shoot for a credit score above the mid-600s, but an ideal score would be above 700.
  • Debt-to-income ratio (DTI): Your lender will take a look at your DTI, which is your fixed monthly debt divided by your gross monthly income, turned into a percentage. For both a HELOC or home equity loan, most lenders will require a debt-to-income ratio of 43% or less.

Have Your Home Appraised

You will also need to have your home appraised for both a home equity loan and HELOC. A home appraisal refers to when a real estate appraiser determines the fair market value of your home.

The appraisal processes for HELOCs and home equity loans are similar because it's likely you won't have to undergo a full appraisal. It may be done with a computer instead.

Pay Closing Costs

You will pay closing costs for both HELOCs and home equity loans, though home equity loans are often higher. Closing costs depend on your type of loan and where you live. If you want more information and a clear number on how much you’ll spend on closing costs, you should consult your lender.

Line Of Credit Vs. Home Equity Loan: Which Is Right For You?

Which is right for you, a line of credit or a home equity loan?

  • Home equity loan: If you need a large sum of cash to cover an emergency, for education or another need and prefer a fixed monthly payment after you borrow, a home equity loan may make sense for you.
  • HELOC: If you prefer borrowing cash on a revolving basis, a HELOC could work well for you. The HELOC could be great for DIYers or real estate investors who flip houses because you'll have access to money when you need it but don't have to pay for the loan until you actually use it.

The Bottom Line: Keep Your Mortgage But Tap Your Home Equity

As mortgage rates rise, homeowners can keep their current low interest rate home loans but still access the money tied up in their home.

A home equity loan gives you an upfront lump sum that you repay in fixed payments with a fixed interest rate. A HELOC lets you tap into equity as needed up to a certain limit. HELOCs typically have a variable interest rate. Think through the right home equity option for your particular situation. Your lender can also help you decide.

Start an application online now for a home equity loan with Rocket Mortgage.

1 Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Iowa is $61,000). Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. Not available in Texas. This is not a commitment to lend.

Miranda Crace

Miranda Crace is a Senior Section Editor for the Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate, and personal loans for over 10 years. Miranda is dedicated to advancing financial literacy and empowering individuals to achieve their financial and homeownership goals. She graduated from Wayne State University where she studied PR Writing, Film Production, and Film Editing. Her creative talents shine through her contributions to the popular video series "Home Lore" and "The Red Desk," which were nominated for the prestigious Shorty Awards. In her spare time, Miranda enjoys traveling, actively engages in the entrepreneurial community, and savors a perfectly brewed cup of coffee.