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Is a HELOC better than a home equity loan with inflation cooling?

A HELOC could be a wise choice as inflation dampens.  Getty Images

If you plan on tapping into your home's equity, you have a couple of options to do so without any changes to your current mortgage. Those options include: 

  • Home equity loan: A home equity loan is commonly referred to as a second mortgage. When you take out a home equity loan, you access the total value of the loan immediately. Moreover, home equity loans typically come with fixed interest rates and payment schedules — though there are some variable options available. 
  • Home equity line of credit (HELOC): A HELOC is like a credit card that's backed by your home. It's a revolving line of credit that you can use anytime you'd like during the draw period. Of course, HELOCs are capped at a predetermined spending limit. In most cases, these loans come with variable interest rates. Also, your minimum monthly payment will rise and fall with your HELOC balance. 

Interest rates are one of the primary factors borrowers consider when comparing these two options. Home equity loans usually come with fixed rates while HELOCs are known for variable interest rates. As inflation cools, some suggest that the interest rate environment will cool as well. So, does the current state of inflation mean that HELOCs are the better option?

Find out the HELOC rates you could qualify for now

Is a HELOC better than a home equity loan with inflation cooling?

Over the past couple of years, the Federal Reserve has increased its target federal funds rate multiple times. That has sent interest rates higher on home equity loans and HELOCs. But, the Federal Reserve increased its target federal funds rate in response to high levels of inflation. 

In October, the year-over-year inflation rate came in at 3.2%. That's down from 3.7% in September, suggesting that the Federal Reserve's interest rate hikes have had a positive impact on economic activity. If the inflation rate continues in the downward direction, there's a possibility that the Federal Reserve will reduce rates at some point soon. With that in mind, here are a couple of reasons why a HELOC may be better than a home equity loan at the moment: 

Variable interest exposes you to rate decreases

"HELOCs typically have a variable interest rate — one that changes," explains Bill Banfield, EVP of Capital Markets for Rocket Mortgage. That means a HELOC's interest rate "could come down if rates fall." But Banfield warns, it "could also go up if rates increase."

That means if you take out a home equity loan today, you can expect to pay today's high interest rates until you pay the loan off or refinance it. On the other hand, if you take out a HELOC today and rates fall, chances are that you'll end up paying lower rates on your loan in the future. 

Take advantage of a HELOC's variable rates today

You don't have to max out your borrowing power

When you take out a home equity line of credit, your lender will give you a spending limit. That's the total amount of money you can borrow against your home through the HELOC at any given time. However, you don't have to borrow the total amount. 

Instead, you can borrow the amount of money you need right now and save the rest of your borrowing power for when you may need it in the future. Not only does this offer a financial cushion of sorts, but it also means that you may be able to borrow smaller amounts of money now while interest rates are high and maintain access to money later if interest rates fall. 

Why a home equity loan may be the better option

"The main difference between a home equity loan and a HELOC is that in a home equity loan, the homeowner gets an upfront lump sum that is repaid in fixed payments, whereas a HELOC lets someone tap into their equity as needed up to a certain limit," says Banfield. 

So, a traditional home equity loan may be a better fit if: 

  • You need a lump sum of cash immediately: Home equity loans give you a way to access a large portion of your home equity at once.
  • You want a fixed payment: HELOCs come with variable payments while home equity loans typically come with fixed payments. If you find it difficult to budget around variable payments, a home equity loan may be your best option. 

Get the home equity loan you need now

The bottom line

HELOCs are typically a compelling option as inflation cools because they give you the opportunity to take advantage of any potential rate reductions. On the other hand, "no one has the rate crystal ball, so the choice is a best guess," says Mark Charnet, founder and CEO of American Prosperity Group. If you believe dampening inflation means rates will fall, Charnet says, "a HELOC would be the better choice." Still, there are times when "the standard home equity loan would be better." So, you should consider your unique situation as you decide between the two. 

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