Home equity loan vs HELOC: Know the difference

Please note: Discover® Home Loans offers a home equity loan product, but does not offer HELOCs. 

If you’re a homeowner, using your home’s equity to secure a loan or a line of credit can be an attractive way to borrow money.

While there are slight differences between a home equity loan and a home equity line of credit (HELOC), they both can offer higher borrowing limits than unsecured personal loans.

When deciding between a home equity loan vs. HELOC, you’ll want to know the basic distinctions between these personal financing options to find the one that will work best for you.

What is a home equity loan?

The money you have invested towards owning your home (your home’s equity) can be used as security for home equity loans:

• After your loan closes, the entire amount of your loan will be deposited in the account(s) you select.
• Most lenders will consider lending home equity loan amounts that are equal to 85% of your home equity, though Discover Home Loans lends up to 90% in certain circumstances.
• The interest rate for a home equity loan is typically a fixed rate which gives you the assurance of a fixed monthly payment.
• A home equity loan repayment period will typically last 10 to 30 years.
• Many home equity loans will also include closing costs. However, when you take out a home equity loan with Discover, you’ll pay no origination fees with no cash due at closing.
• Interest payments on home equity loans may be tax deductible under certain conditions when the loan goes towards home renovation expenses. Check with your tax advisor to see if this applies to your situation.

What is a home equity line of credit (HELOC)?

Your home’s equity can be used as security for home equity lines of credit, a type of revolving credit:

• On the first day of a home equity line of credit, you are given access to an account with the agreed credit limit. You are charged interest only on any withdrawals from the account, which can make the repayment amounts on HELOCs vary from month-to-month.
• Most lenders will consider home equity line of credit limits that are equal to 85% of your home equity.
• With a variable interest rate, HELOCs may offer a lower starting interest rate than home equity loans, but the interest rate can change based on U.S. economic trends.
• Some HELOCs allow monthly payments towards the principal of the loan to be delayed until the final day of the loan. While this can lower your monthly payments, it can also create a balloon payment when the loan ends. You should make sure you understand the full repayment schedule for the line of credit when applying for a HELOC.
• A HELOC repayment period will typically last 5 to 30 years with monthly payments that depend on how much is withdrawn and the according interest rate at the time of withdrawal.
• A HELOC will define a withdrawal period, which is the time period when you can withdraw funds from the line of credit (typically 5 to 10 years). When the withdrawal period expires, you will typically repay the loan balance at that time over 10 to 20 years. You may also apply for a renewal of the line of credit, but approval of that renewal will be at the discretion of the lender.
• Aside from closing costs, HELOCs may charge other fees for things like account maintenance, early payoff, or nonuse.
• Like a home equity loan, interest payments on HELOCs may be tax deductible when the funds are used for home renovation, although you need to check with your tax advisor to ensure this is the case.

Differences between a home equity loan and a home equity line of credit

As you examine the comparison of a fixed loan vs. a line of credit, you will find some important differences between the two products.

Fixed interest rates vs. Variable interest rates

A home equity loan charges interest at a fixed rate, while most HELOCs charge interest at a variable rate.

Fixed interest rates provide you with predictable repayments, allowing your home equity loan lender to share with you a schedule of consistent repayment amounts over the life of the loan.

Variable interest rates are based on the interest rate on a standard index like the lending institution’s prime rate or U.S. Treasury bill rate plus a margin set by the lender. This means they can fluctuate as the index changes based on factors of the U.S. economy.

HELOC interest rates generally also have a floor rate (the lowest rate that can be charged to you) and a cap (the highest rate that you can be charged).

As you compare variable interest rates for HELOCs, you will want to know:

• Which index is used and what is the current variable?
• What is the amount of margin that the lender charges?
• How frequently does the interest rate get adjusted?
• What are the interest rate cap and floor?

Lump sum disbursement vs. Withdrawals as needed

Another difference between a HELOC and a home equity loan is how you receive the money.

A home equity loan is disbursed as a lump sum. The entire loan amount will be deposited into your preferred account(s) when you receive your funds.

A home equity line of credit is typically set up as a separate account from which you can withdraw funds only as you need them.

Additionally, a HELOC will assign a withdrawal window. You will only be able to withdraw funds during that time period. When that window expires, you can apply for an extension to the line of credit, but your request may not always be granted.

Fees and penalties

Both home equity loans and HELOCs will assess a variety of closing costs and can include prepayment penalties if you pay back the loan before the scheduled term. Your lender is required to provide you these fees and penalties up front so you can evaluate which lender provides the most attractive terms.

HELOCs, unlike home equity loans, may also include annual fees over the life of the repayment period and some may also charge each time you make a withdrawal from your personal line of credit.

Find the best home equity product for your personal financing

In judging a fixed loan vs. a line of credit, you will find that HELOCs are best for upcoming expenses that aren’t set in stone while home equity loans are perfect when you have a specific amount to pay.

From there, choosing between these products should be done by evaluating offers from different lenders to understand who offers the lowest interest rate and the least amount of additional fees. These are factors that can save you money over the life of the loan.

As always, when choosing any financial product, make sure you research your options and lenders so you can make the decision that’s right for you.