HELOC vs. home equity loan: Which is best for you?

A home equity loan¹ and a home equity line of credit (HELOC) are both financing options for homeowners who are looking to borrow money. Both are a type of second mortgage that allows homeowners to borrow against their equity to get better loan terms. If you choose one of these options, you’ll need to keep up with an additional payment each month alongside your primary mortgage - or risk losing your home.

While both home equity loans and HELOCs allow you to borrow against your home equity, they have key differences when it comes to flexibility, interest rate, and repayment structure. Here, we’ll break down the key differences between HELOCs and home equity loans to help you choose the best option for your situation.

How does home equity work?

Equity is the percentage of the home you actually own relative to what you still owe on it. With each mortgage payment you make, you build equity in your home. You can also build equity if the value of your property increases. To calculate the amount of equity you have in your home, you take the current property value and subtract what you still owe on your mortgage.

Once you’ve built up enough equity, you can use it as collateral to borrow money. Lenders typically require you have at least 15% to 20% equity before you can tap into it. This type of secured loan can get you access to lower interest rates than other types of loans. However, using your home as collateral also means that if you can’t repay the loan, you could risk foreclosure on your home.

You can use the money you borrow for whatever purposes you wish. Common reasons homeowners borrow against their equity include home renovations, tuition, paying down debt, or unexpected medical expenses.

What is a 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 up to a certain amount. You can use the equity in your home to pay for whatever you need, such as home improvements, education and consolidating credit card debt. You can typically borrow up to 80% to 85% of your home’s value, including what you still owe on the primary mortgage.

There are two phases with HELOC - the draw period and the repayment period. The draw period is when your line of credit is open and available for you to use as needed. During the draw period, the only payments you’re required to make are interest payments on any money borrowed. The length of the draw period is typically 10 years but can vary depending on the HELOC.

Once you reach the end of your draw period, you'll have to make repayments based on your principal and remaining interest. The repayment period typically lasts up 20 years. The amount you owe each month will depend on your interest rate and how much you borrowed.

HELOCs typically come with a variable interest rate. This means that the interest rate on your loan will start off lower for an introductory period. Once that period is over, your interest rate will change at a regular interval and can fluctuate based on changes in the market.

Rocket Mortgage^Ⓡ does not currently offer HELOCs, but we do offer a Home Equity Loan.

HELOC pros and cons

Let's take a look at some of the pros and cons of HELOCs.

What is a home equity loan?

Home equity loans are another type of second mortgage that allow you to use the equity in your home as collateral to borrow money. Your lender loans money to you as a lump sum when you take out the loan and you make your monthly payments during a repayment period.

Home equity loans typically come with a fixed interest rate that doesn’t change over the life of your loan. Because you’re borrowing a lump sum at a fixed interest rate, you’ll have predictable, even monthly payments as you repay the loan.

Like with a HELOC, you can typically borrow up to 80% to 85% of the value of your home, minus what you owe on your mortgage. The Home Equity Loan option from Rocket Mortgage allows you to access $45,000 - $350,000 of your home’s equity in 10- or 20-year terms.

Home equity loan pros and cons

Now let’s take a look at some of the upsides and downsides to home equity loans.

HELOCs and home equity loans: Key differences

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

• Type of loan: A HELOC is a type of revolving debt, 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. A home equity loan is an installment loan that you repay over time with regularly scheduled payments.
• Interest rate: A home equity loan has a fixed interest rate, which means it won’t change over the life of your loan. A HELOC has a variable interest rate that fluctuates based on an underlying benchmark index or interest rate.
• Access to funds: A HELOC is a line of credit that you can draw from as needed over a set period. A home equity loan comes as a lump sum.
• Structure: HELOCs have a draw period and repayment period, while home equity loans have fixed payments.

HELOC and home equity loan requirements

In order to get approved for a HELOC or home equity loan, you’ll need to meet certain requirements:

• Equity: Most lenders will require that you have at least 15% - 20% equity in your home to get a HELOC or home equity loan.
• Credit score: You’ll typically need a minimum credit score of at least 620 to get a home equity loan or HELOC. Some lenders require a minimum credit score of 680.
• Debt-to-income ratio (DTI): Your debt-to-income ratio 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 that your DTI not exceed 43%.
• Appraisal: To get a home equity loan or HELOC, you’ll need to have your home appraised to determine the fair market value of your home. Luckily, these appraisals tend to be less involved than the appraisal you needed to purchase your home and can often be done virtually.
• Closing costs: Closing costs for HELOCs and home equity loans tend to range from 2% to 5% of the total loan amount.

Line of credit vs. home equity loan: Which is right for you?

If you’re trying to decide between a home equity loan and a HELOC, the answer will depend on how you’re using the money and how you’d prefer to repay it.

When to choose a HELOC

If you prefer borrowing cash on a revolving basis or aren’t sure exactly how much you’ll need to borrow in advance, a HELOC could work well for you. For example, if you’re using it to pay tuition and schooling costs, you may prefer to have a line of credit you can draw on multiple times. The HELOC can also be helpful to homeowners looking to perform phased home renovations and don’t know in advance exactly how much it will end up costing.

When to choose a home equity loan

If you need a large sum of cash to pay off debt or cover a large emergency expense, a home equity loan might be right for you. For example, you want to remodel your kitchen your contractor has given you a specific quote. Home equity loans also come with a fixed interest rate and predictable monthly payments.

Home equity loan vs. line of credit FAQ

Let’s take a look at the answers to some frequently asked questions about home equity loans and HELOCs.

Which is better, a HELOC or a home equity loan?

HELOCs and home equity loans each come with their own sets of pros and cons. A home equity loan is often better if you want to borrow a lump sum for a fixed interest rate. A HELOC can be the right choice if you want a line of credit you can draw from over time.

What’s the minimum credit score for a HELOC or home equity loan?

The minimum credit score for a HELOC or home equity loan will vary depending on the lender. You’ll typically need a credit score of at least 620 to qualify.

Do HELOCs have closing costs?

Yes, HELOCs typically come with closing costs that range from 2% to 5% of the total loan value.

Is it better to refinance or get a HELOC or home equity loan?

A cash-out refinance² is an alternative financing option that also allows homeowners to borrow money against their home equity. With a refinance, your current mortgage is replaced by a new, larger loan and you withdraw the difference in cash. If interest rates have dropped since you first took out your mortgage, a cash-out refinance can be a helpful way to borrow money and reduce your interest rate.

However, the opposite is true if interest rates have increased. A cash-out refinance also typically comes with higher closing costs and can mean it takes longer for you to pay off your mortgage.

Can I pay off a HELOC early?

You can pay off your HELOC early if you have the funds available. However, you should first check to see if your lender charges a prepayment penalty.

The bottom line: Tap into your home equity with a HELOC or home equity loan

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.

While we do not currently offer HELOCs, you can apply for a Rocket Mortgage Home Equity Loan today.

[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. 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. This is not a commitment to lend.

[2] Refinancing may increase finance charges over the life of the loan.