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HELOCs vs. home equity loans: Which is better?

HELOCs and home equity loans both have unique benefits that homeowners should explore. Getty Images/iStockphoto

Persistent inflation and rising interest rates are reverberating throughout the economy and Americans are feeling the pinch. And with a potential recession on the horizon, many are looking for ways to make ends meet and pay off high-interest credit cards and other debt.

If you're a homeowner, you can achieve both objectives by taking out a home equity line of credit (HELOC) or home equity loan. These two types of second mortgages use your home's equity as collateral while allowing you to access the money you need. Home equity is the difference between your mortgage balance and your home's current market value.

A HELOC is a revolving line of credit that works similarly to a credit card. You can borrow as often as you like, for as little or as much as you need up to your credit limit. HELOC lenders may allow you to borrow 60% to 85% of your home's equity. They typically come with variable rates and repayment terms for as long as 30 years. Your repayment term includes a draw period, often for 10 years, in which you can withdraw money. Once the draw period ends, you'll enter a repayment period, typically lasting 20 years.

A home equity loan enables you to borrow a lump sum of money that you must repay over a fixed repayment term, typically ranging from five to 30 years. Generally, interest rates are fixed, and you can borrow as much as 80% to 85% of the equity in your home. In other words, if your home has $100,000 in equity, you may qualify for a home equity loan for up to $80,000 to $85,000.

The differences between both options - and the benefits - are unique for each homeowner. You can explore both options to determine which one is better for you here

When a HELOC may be better

Because a HELOC uses your home as collateral, ensure that you understand the repayment plan before signing the agreement. That means you could lose your home if you fail to repay the HELOC as agreed. As you investigate HELOCs, it's helpful to understand the scenarios in which a HELOC may benefit you. Here are three scenarios in which it may be your better option:

  • When you need ongoing access to funds: HELOCs allow you to borrow repeatedly for only as much as you need up to your approved limit. Keep in mind, you'll only pay interest on the amount you withdraw, not the amount of your credit limit. Having the flexibility to borrow as needed makes HELOCs a good option, particularly if you need access to money over an extended period.
  • When you want a credit line to meet future expenses: Perhaps you need cash now to pay for an emergency medical bill, but you know you'll need additional funds in a few years to cover a child's college tuition and related expenses. Since you don't have to accept the full borrowing amount right away—and pay all that interest—a HELOC may provide a more cost-effective option to cover your immediate and future expenses. However, you should exhibit discipline when spending to avoid maxing out your borrowing limit, which could prevent you from accessing money in the future.
  • You want lower interest rates and cheaper closing costs: As a general rule, HELOCs have lower interest rates and closing costs than home equity loans. These costs include fees for your application, title search, and attorney document preparation. Not all HELOCs charge closing costs, but those that do typically charge between 2% and 5% of the loan amount.

You can easily check your local HELOC offers online today.

When a home equity loan may be better

If a HELOC won't meet your needs, consider the benefits of a home equity loan. Here are three scenarios where a home equity loan may be more advantageous than a HELOC:

  • When you want a fixed interest rate: Unlike HELOCs, which usually come with variable interest rates, home equity loans offer a fixed interest rate. A home equity loan can be a better option if you want a monthly payment that remains the same and is protected from potential interest rate hikes.
  • When paying a substantial expense: Accessibility to a sizeable lump-sum borrowing amount makes a home equity loan a good option for covering a significant one-time expense. Borrowers commonly use home equity loans to fund home improvement projects, cover medical bills and pay off credit card debt.
  • When you want an installment loan: A home equity loan is a type of installment loan, like a personal or auto loan. You may prefer the predictability of an installment loan in which you make regular payments for the same amount until your loan is repaid in full.

Learn more about your home equity loan options here now.

The bottom line

Home equity loans and HELOCs share many similar benefits, such as the ability to borrow against the equity in your home. Similarly, you may qualify for a tax deduction if you use funds from a home equity loan or HELOC to build or substantially improve your home.

If you're deciding between these two borrowing options, the decision may come down to which one meets your unique financial needs. Before you agree to a home equity loan or HELOC, compare the terms and conditions of each to see which is most beneficial for your situation. Start exploring your options online now to discover which one is better for you.

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