HELOC vs. Home Equity Loans: A Comparison
Since home prices have gone up over the past few years, many homeowners now have more equity than ever. If you’re one of them, you may wonder how to use it to pay for something useful, like a big project or taking care of other debts.
You can use a home equity line of credit (HELOC)* or a home equity loan** to get the most out of the value of your house.
If you're ready to leverage your home’s value, Rate offers an easy HELOC application process that can help you take the next step.
What is a HELOC?
A HELOC lets you borrow money based on the amount of equity you've built up in your home with a line of credit.
It gives you flexible access to funds, unlike traditional home loans that give you a single lump-sum. This makes it perfect for covering ongoing costs like home improvements, school costs, high medical bills or even consolidating high-interest credit card debt.
You can take out money as needed during your draw period, which with a HELOC usually lasts from five to 10 years. Monthly bills are low, since you might only have to pay interest during this time.
After the draw period is over, you'll enter the repayment period, during which you’ll have to pay back the loan amount plus interest over a set period of time, normally 10 to 20 years.
HELOC requirements
For a HELOC, lenders assess specific factors to determine eligibility. These requirements help lenders check whether borrowers can handle a second mortgage or a combined loan tied to their home’s equity.
You typically need a credit score of at least 620 for HELOC approval, even though some lenders may require higher scores to offer lower interest rates.
A strong credit profile, which includes good credit and a history of timely payments, can also improve your chances of favorable HELOC rates and more flexible terms.
Lenders usually expect an loan-to-value (LTV) ratio of 80% or less, meaning you should have at least 20% appraised value equity in your home. This level of equity helps demonstrate you’ve built enough of a stake in your property to minimize the risk to the lender.
Lenders look closely at your gross monthly income and debt-to-income (DTI) ratio to determine if you can manage monthly payments on a new loan.
This ratio takes into account your current obligations like credit card payments, existing monthly debt and other installments like personal loans.
Ideally, your DTI ratio should be under 43%.
Stable income, shown through pay stubs and tax returns, reassures lenders of your ability to handle payments long-term.
What is a home equity loan?
A home equity loan allows you to borrow a lump-sum based on the equity you've built up in your home. It’s also known as a second mortgage.
This type of loan gives you a set amount of money upfront, which you then pay back over a set term with regular monthly payments.
A home equity loan is better than a HELOC if you need a set amount of money as a one-time payment, like school costs, a big home renovation or consolidating your personal loan debt.
Another advantage of a home equity loan usually comes with a fixed interest rate, which means your loan payments stays the same over time.
Home equity loan requirements
Requirements for home equity loans are similar to HELOC requirements but with a few differences. These differences can make a home equity loan more suitable for certain borrowers, particularly those who like structured repayment terms.
Credit score needed for a home equity loan
A credit score of 620 or higher is generally required for a home equity loan, even though some lenders might set a higher benchmark.
A higher score improves your chances of getting favorable home equity loan rates. Lenders may look at your history of interest payments and other debts, such as credit cards, to assess the risk they’ll take by giving you a home equity loan.
How is the amount of equity in the home determined?
Many lenders also require a home appraisal to verify a property’s appraised value, confirming its market value equals the loan request.
The appraisal helps lenders determine the amount of money they’re comfortable lending to you.
Required loan-to-value (LTV) ratio for home equity loans
For home equity loans, the LTV cap is typically around 80%, meaning you must have at least 20% equity in your property.
HELOC vs. home equity loans: Pros and cons
Pros of HELOC
- Flexible access to funds when needed
- Interest-only payments during the draw period
- Can be used for ongoing expenses or projects
- Typically lower initial payments compared to loans with fixed rates
Cons of HELOC
- Variable interest rates can lead to fluctuating payments
- Risk of overspending due to access to revolving credit, which can ultimately lead to a foreclosure if you’re not careful
Pros of a home equity loan
- Fixed interest rates for stable, predictable payments
- Consistent monthly payments make budgeting easier
- One-time lump-sum can be used for large, planned expenses
- Ideal for people who want a straightforward fixed monthly payments
Cons of a home equity loan
- Less flexibility; can’t borrow more once the loan is disbursed
- Closing costs and fees similar to your original mortgage
How to determine which is right for you
Which one should you choose? Here are some things to consider.
Consider your financial goals
How are you going to spend the money? A HELOC might be a better choice if you need to be flexible with ongoing costs, like making home improvements or paying for several projects over time.
You can get your money when you need it, which is great for costs that you can't predict.
A home equity loan, on the other hand, might be better if you only need the money for one thing, like a big renovation, or consolidating other debt.
You get a lump-sum upfront and have a set amount of time to pay it back in monthly installments. This helps you stay on track with your finances by giving you a clear plan.
Evaluate your budget and cash flow
If you're comfortable with the idea of payments and interest rates going up or down, a HELOC might be a good choice for you. Borrowers who have a steady flow of cash and are ready for changes in their monthly payments may find these features useful.
But if you like knowing exactly how much you'll have to pay each month, a home equity loan might be better for you. You'll know exactly what to expect each month with a set rate, which can make things easier to handle if you're on a tight budget.
Assess interest rate preferences
Interest rates can change over time. Most HELOCs have variable rates, which means that you may experience higher interest rates and your monthly payments may go up as the market changes.
A home equity loan might be a better choice for you if you'd rather lock in a set rate to avoid surprises and keep your payments stable.
How to apply for a HELOC
HELOCs and home equity loans offer unique ways to access your home equity for expenses like home improvements, debt consolidation or unexpected costs.
A HELOC brings flexibility, letting you borrow what you need when you need it. If you’re ready to take advantage of this option, Rate’s HELOC makes the process simple with competitive interest rates and flexible terms to suit your financial goals.
Explore how Rate’s HELOC can unlock your home’s potential and give you the funding you need right when you need it.
*Rate home equity line of credit (HELOC) is an open-end product where the full loan amount (minus the origination fee) will be 100% drawn at the time of origination. The initial amount funded at origination will be based on a fixed rate; however, this product contains an additional draw feature. As the borrower repays the balance on the line, the borrower may make additional draws during the draw period. If the borrower elects to make an additional draw, the interest rate for that draw will be set as of the date of the draw and will be based on an Index, which is the Prime Rate published in the Wall Street Journal for the calendar month preceding the date of the additional draw, plus a fixed margin. Accordingly, the fixed rate for any additional draw may be higher than the fixed rate for the initial draw. This product is currently not offered in the states of New York, Kentucky, West Virginia, Delaware and Maryland. The HELOC requires you to pledge your home as collateral, and you could lose your home if you fail to repay. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone. Borrowers must meet minimum lender requirements in order to be eligible for financing. Available for primary, second homes and investment properties only. Dependent on minimum credit score and debt-to-income requirements. Occupancy status, lien position and credit score are all factors to determine your rate and max available loan amount. Not all applicants will be approved. Applicants subject to credit and underwriting approval. Contact Rate for more information and to discuss your individual circumstances. Restrictions apply.
**Available as closed end, fixed rate, second lien. Eligibility for second home and investment properties allows for only 10 total financed properties. The total of first and second liens cannot exceed $3M. No more than two mortgage liens are permitted on a single property. Financing subordinate to the new second lien is not permitted. First lien mortgages must be fully amortizing, fixed rate or adjustable rate mortgage loans only. This product requires you to pledge your home as collateral, and you could lose your home if you fail to repay. Minimum equity and FICO score requirements apply and impact total loan amount available from $50,000 to $500,000. Maximum debt to income cannot exceed 50%. This product is not a revolving line of credit. State and product restrictions vary so talk to your loan officer about what options may be available to you. Not available in all states. Additional restrictions apply. Not all applicants will be approved. Applicant subject to credit and underwriting approval. Not a commitment to lend. Contact Rate for more information.
