As more and more homeowners look to use their home equity as an option for low-interest financing, it can be confusing to know if a home equity loan or a home equity line of credit (HELOC) is the better option. Both are secured by your home and offer rates that are lower than unsecured loans or credit cards and may offer tax benefits depending on how the loan is used. Both can be good solutions to finance a variety of uses including home improvement, debt consolidation, major expenses (weddings, education, etc.), and refinancing. However, there are differences to understand so you can select the right option for you.
Home Equity Loan vs HELOC: At-a-glance comparison
|Home Equity Loan||Home Equity Line of Credit|
|How are funds delivered?||One lump sum||Similar to a revolving line of credit, you are approved for an amount that can be withdrawn as needed during a time period established by the lender|
|What is the type of interest rate?||Typically fixed interest rate which means your monthly payment and rate remains the same month-to-month||Typically variable interest rate that may change if the rate index changes. Some lenders offer a hybrid or fixed rate option where all or some of the amount borrowed can be converted to a fixed rate. Typically, fixed rates tend to be higher and there may be a fee associated with the rate conversion|
|How long is the repayment term?||5 to 30 years, depending on the lender||10 to 30 years, depending on the lender. The loan term is broken up into the draw period where you can withdraw money and make small, interest payments and the repayment period where you cannot withdraw any money and are expected to make regular monthly payments of interest and principal|
|Are there any closing costs/fees?||Depends on the lender, but can include application, origination, and appraisal fees, and also closing costs. However, with Discover Home Equity Loans, you do not pay these fees, Discover does and there is $0 owed at closing||Depends on the lender, but can include application, origination, and appraisal fees, and also closing costs|
|Are there any annual or maintenance fees?||No annual fees||Typically have annual fees|
|Is this tax deductible?||The interest paid is tax deductible if the money borrowed is used for home renovations. Consult your tax advisor for details||The interest paid is tax deductible if the money borrowed is used for home renovations. Consult your tax advisor|
|Prepayment penalty||Depends on the lender||Depends on the lender|
Home equity loans typically carry fixed interest rates. In a changing rate environment, a fixed rate loan can provide a borrower some assurance because the monthly payment amount and interest rate remains the same over the life of the loan. On the other hand, HELOCs typically carry a variable interest rate that will change periodically if the rate index changes. If the index increases or decreases, the interest rate will increase or decrease and your monthly payment will increase or decrease. Some lenders now offer a hybrid or fixed rate option for a HELOC. You can convert all or some of the money from a variable rate into a fixed rate during the draw period, typically for a fee. While this can give you a sense of certainty, the interest rates on fixed rate HELOCs are often higher than market rates and there may be a fee associated with the rate conversion. Because home equity loans and HELOCs are secured by your home, interest rates are typically lower than unsecured loans like credit cards or personal loans.
Home equity loans are disbursed in one lump sum and the borrower is expected to make regular monthly payments of principal and interest for the agreed-upon repayment term. Some lenders may charge a pre-payment fee if the loan is paid in full before the end of the repayment term. With Discover Home Equity Loans, if the loan balance is paid in full within 36 months after your loan closes, you will be required to reimburse some of the closing costs, not to exceed $500.
HELOCs work like a credit card. The borrower can withdraw money as needed during a period of time set by the lender, known as the draw period. If the borrower withdraws money during the draw period, they may be required to make small, interest payments. Once the draw period ends, the borrower can no longer withdraw any more money and is now expected to make full payments of principal and interest for the agreed-upon repayment term. While there is money available to the borrower with a HELOC, the lender can revoke the amount available if the borrower’s financial situation worsens or if their home value changes.
Closing costs and fees vary by lender. Home equity loans act like a mortgage with various fees and closing costs, but it depends on the lender. A HELOC may have upfront costs including an application fee, title search, and appraisal fees. In addition, a HELOC may include fees throughout the life of the loan, including an annual membership fee or a transaction fee. It’s best to shop around and discuss all fees with lenders. Instead of HELOCs, Discover offers home equity loans with no application fees, no origination fees, no appraisal fees, and no cash due at closing. If you’re interested in applying for a home equity loan from Discover, you can apply online now and see if you prequalify in minutes.
When considering your options, make sure you evaluate how you plan to use the money and how does this fit within your long-term financial plans. It’s important to not only compare your options but also compare lenders to determine what loan best works for your unique situation.