The difference between a home equity loan and a HELOC

A home equity loan is a one-time loan against the value you have built up in your house. You borrow a fixed amount, receive it as a lump sum, and repay it on a fixed schedule with a fixed interest rate — much like a traditional mortgage. A HELOC (home equity line of credit) works more like a credit card: the lender approves you for a maximum amount, you draw from it as you need it, and you pay interest only on what you actually borrow.

The choice between them depends on what you need the money for and how you prefer to manage debt. If you know exactly how much you need — say, $50,000 for a kitchen renovation — a home equity loan gives you certainty: you get the money upfront and know your monthly payment. If you're not sure how much you'll need, or you want to draw money over time, a HELOC offers flexibility but requires discipline, because the temptation to keep borrowing can be real.

Both are secured by your house, which is why the interest rates are lower than credit cards or personal loans. That same security is also the risk: if you cannot pay, the lender can foreclose.

Key Takeaways

  • A home equity loan gives you a fixed lump sum with a fixed rate and fixed monthly payment, while a HELOC lets you borrow up to a limit and pay interest only on what you use.
  • Both are secured by your home's equity — the difference between what your house is worth and what you owe on your mortgage.
  • Interest rates on both are typically lower than credit cards because your home backs the loan, but that also means your home is at risk if you default.
  • Most HELOCs have a draw period (usually 5 to 10 years) when you can borrow, followed by a repayment period when you cannot borrow anymore and must pay down the balance.
  • Lenders typically allow you to borrow 80 to 90 percent of your home's equity, meaning you must have built up real value in the house first.

How much equity you need and how lenders calculate it

Equity is the gap between what your house is worth and what you still owe on your mortgage. If your home is worth $400,000 and you owe $250,000 on the mortgage, you have $150,000 in equity. Most lenders will let you borrow against 80 to 90 percent of that equity, so in this example you could borrow roughly $120,000 to $135,000.

To find out how much you can borrow, you need to know two numbers: your home's current market value and your mortgage balance. Your mortgage lender can tell you the balance when ready. The market value is trickier. Some lenders will accept a recent appraisal, a tax assessment, or an automated valuation from a service like Zillow or Redfin, but many require a formal appraisal done by a licensed appraiser — which costs $300 to $600 and takes one to two weeks. Ask the lender upfront what they will accept.

If you have very little equity — say, less than 10 percent of your home's value — most lenders will turn you down. If you have recently bought the house or refinanced, you may not have built up enough equity yet. In that case, you would need to wait or look for a lender willing to work with lower equity, though they will charge a higher rate.

Interest rates, fees, and the total cost of borrowing

Home equity loans and HELOCs typically carry interest rates 1 to 3 percentage points higher than a primary mortgage, but lower than credit cards or personal loans. The exact rate depends on your credit score, the lender, current market rates, and how much equity you are borrowing against. A HELOC rate is usually variable, meaning it moves with the prime rate; a home equity loan rate is usually fixed.

Beyond interest, expect to pay closing costs similar to a mortgage: appraisal fees ($300–$600), title search and insurance ($200–$400), origination fees (0.5 to 1 percent of the loan amount), and possibly attorney fees if your state requires it. Some lenders advertise "no closing cost" HELOCs, but they typically roll those costs into a higher interest rate, so you pay them over time instead of upfront. Do the math: if the rate is 0.5 percent higher and you are borrowing for 10 years, that "free" closing cost may cost you thousands.

For a HELOC, also watch the repayment terms. Many HELOCs have a 10-year draw period followed by a 20-year repayment period. During the draw period, you might pay interest-only, which keeps payments low. Once the repayment period starts, your payment jumps because you now have to pay down principal as well. Some HELOCs convert to fixed-rate loans at that point; others stay variable. Understand the terms before you sign.

When a home equity loan makes sense

A home equity loan works well when you have a specific, large expense and you want predictability. Common uses include major home repairs or renovations, paying off high-interest debt (like credit cards), funding education, or covering a medical emergency. Because the rate is lower than credit cards and the payment is fixed, it can be a smart way to consolidate debt — but only if you do not run up the credit cards again afterward.

The fixed payment also makes budgeting easier. You know exactly what you owe each month for the next 10, 15, or 20 years. If interest rates are rising, locking in a fixed rate now protects you from future increases.

The downside is that you receive all the money at once, whether you use it when ready or not. If you borrow $50,000 but only spend $30,000 in the first year, you are still paying interest on the full $50,000. You also cannot easily adjust the loan amount later if your needs change.

When a HELOC makes sense

A HELOC is useful when you are not sure how much you will need or when you will need it. Contractors doing a renovation over several months, business owners managing seasonal cash flow, or homeowners planning multiple projects over a few years often prefer HELOCs because they draw only what they use and pay interest only on that amount.

The flexibility comes with a catch: variable interest rates. If the prime rate rises, your interest rate and minimum payment rise too. During the 2022–2023 rate increases, many HELOC borrowers saw their payments jump 30 to 50 percent. If you cannot handle that risk, a fixed-rate home equity loan is safer.

HELOCs also require discipline. Because you can keep borrowing as long as you stay within your limit, it is straightforward to treat it like information programs and accumulate debt without a clear repayment plan. If you are already struggling with credit card debt, a HELOC may tempt you to borrow more rather than solve the underlying problem.

The risks of borrowing against your home

The biggest risk is foreclosure. Unlike credit card debt, which a lender can pursue through wage garnishment or a judgment, a home equity loan or HELOC is secured by your house. If you stop paying, the lender can foreclose and sell your home to recover what you owe. This is not a threat lenders make lightly, but it is a real consequence if you fall behind.

A second risk is that your home's value can drop. If you borrow $100,000 against $150,000 in equity and your home's value falls to $300,000 while you still owe $200,000 on the mortgage and $90,000 on the home equity loan, you are underwater — you owe more than the house is worth. You cannot easily sell, and if you must, you will owe money at closing. This happened to many homeowners during the 2008 housing crisis.

A third risk, specific to HELOCs, is payment shock. When the draw period ends and the repayment period begins, your payment can double or triple. If you have not planned for that, it can strain your budget. Some borrowers take out a new HELOC to pay off the old one, which just delays the problem and can leave you with more debt.

How to compare offers and choose a lender

Get quotes from at least three lenders: your current mortgage lender, a bank, and a credit union. Each will quote you an interest rate, closing costs, and the terms of the draw and repayment periods. Ask for everything in writing so you can compare apples to apples.

Pay attention to the Annual Percentage Rate (APR), not just the interest rate. The APR includes the interest rate plus closing costs spread over the loan term, so it gives you a truer picture of the total cost. A loan with a slightly higher interest rate but lower closing costs might have a lower APR.

For a HELOC, ask specifically about what happens at the end of the draw period. Will the rate convert to fixed? Will you be able to extend the draw period? What is the maximum repayment period? Some lenders are more flexible than others, and that flexibility can matter if rates are high when your draw period ends.

Also check whether the lender will lock in a rate. Some will let you convert a variable-rate HELOC to a fixed rate during the draw period, which can be valuable insurance if rates are rising.

Frequently Asked Questions

Can I have both a mortgage and a home equity loan at the same time?

Yes. The mortgage is the first lien on your home, and the home equity loan is the second lien. If you default, the mortgage lender gets paid first from the sale proceeds, and the home equity lender gets what is left. This is why home equity loans carry higher interest rates — the lender is taking on more risk.

What happens to my home equity loan if I sell my house?

You must pay off the home equity loan from the sale proceeds before you receive any money. The title company handling the sale will collect the payoff amount from the buyer's funds and send it to the lender. If the sale price is too low to cover both the mortgage and the home equity loan, you will owe the difference out of pocket.

Can I deduct the interest on my taxes?

Only if you use the money to buy, build, or substantially improve your home. If you use a home equity loan to pay off credit cards or fund a vacation, the interest is not deductible. Consult a tax professional about your specific situation, as the rules are complex and depend on how you use the funds.

What credit score do I need?

Most lenders require a credit score of at least 620, but competitive rates typically start at 700 or higher. The higher your score, the lower your rate. If your score is below 620, you may still find lenders, but you will pay significantly more in interest.

Can I pay off a home equity loan early without a penalty?

Most home equity loans and HELOCs do not have prepayment penalties, but some do. Ask the lender before you sign. If you plan to pay off early, a loan without a prepayment penalty gives you more flexibility.