HELOC vs. home equity loan: What's the difference?

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• Home equity loans and HELOCs allow you to borrow against the value of your home.
• Both are types of second mortgages, but they differ in how you can access your funds and how you'll repay them.
• You can typically borrow up to 80% or 90% of your home's value, minus the balance of your first mortgage.

If you need to borrow against the equity you have in your home, a second mortgage may be the best way to do so.

Interest rates are often lower on second mortgages than other borrowing options, such as online personal loans or credit cards. Plus, in a high rate environment, a second mortgage is typically preferable to getting a cash-out refinance and potentially taking on a significantly higher rate on your first mortgage.

Home equity lines of credit (HELOCs) and home equity loans are two types of second mortgages that let you borrow against the equity you have in your home. But these two home equity products don't work in the same way. The best fit for you depends on your needs.

HELOC vs. home equity loan

Home equity loans and HELOCs both allow you to borrow against your home's equity, and you can use the funds however you'd like. It's common for borrowers to use second mortgages to pay for things like home repairs or upgrades.

But the way you'll have access to the funds and repay them differs depending on the type of second mortgage you get.

Home equity loan

Home equity loans let you borrow against the equity in your home and receive your funds in a single lump sum. Loan amounts are typically limited by your loan-to-value ratio , or your home value minus your existing mortgage balance. Typically, you'll be able to get a home equity loan up to 80% or 90% of your home's value, minus your current mortgage balance.

Like personal loans , home equity loans come with a fixed interest rate and fixed repayment term. Because of this, you'll also get a fixed monthly payment that doesn't change during the life of the loan. Home equity loans are extremely predictable; you know how much you're borrowing, how long it'll take you to pay it back, and exactly how much you'll owe each month.

You'll start making monthly payments on a home equity loan as soon as you close on the loan.

Find out up front whether your lender charges a prepayment penalty, in case you want to pay back the loan ahead of schedule, and how much you'll be expected to pay in fees and closing costs. Different home equity loan lenders have different fee structures — some have very low fees — so you'll want to compare your options.

Pros of home equity loans:

• Fixed monthly payment
• Your interest rate won't change
• Predictable cost, similar to a personal loan

Cons of home equity loans:

• You're using your home as collateral, so you risk foreclosure if you don't repay
• Some home equity loans have fees, including an origination fee and closing fees
• You are required to figure out how much you want to borrow upfront

HELOC

Where home equity loans function similarly to a personal loan, home equity lines of credit, or HELOCs, work similarly to a credit card . Instead of giving you a lump sum, a HELOC is a line of credit you can borrow against when you need the money. As such, you will only repay amounts of money you borrow in the end.

Like home equity loans, HELOCs usually limit your borrowing ability to up to 80% or 90% of your home's value, and may or may not include fees depending on the lender. They typically come with a variable interest rate, although some lenders offer the option to convert part of your balance to a fixed mortgage rate .

HELOC repayment is split into two periods: the draw period and the repayment period. Often, a HELOC draw period will last 10 years and the repayment will be spread out over 20 years, but term lengths can vary.

You'll only be able to take money out during the draw period. Some HELOC lenders have minimum withdrawal requirements, but aside from that, you'll have the freedom to borrow only what you end up needing — meaning you'll only pay interest on the amount you borrow.

During the draw period, you'll generally make interest-only payments. Once the repayment period begins, you'll no longer be able to make withdrawals from the HELOC, and you'll start making monthly payments that include both the principal and interest.

Their flexibility makes HELOCs a good option if you're working on an open-ended project and aren't sure exactly how much you'll need overall.

But because your payment is based on how much you borrow and your interest rate is variable, your monthly payment amount may be hard to predict — and it could fluctuate over time.

Pros of HELOCs:

• Only pay interest on what you borrow, rather than a full lump sum
• Your variable rate could remain low since it's based on an index
• Many HELOCs come with no fees or low fees

Cons of HELOCs:

• You're using your home as collateral, so you risk foreclosure if you don't repay
• Some HELOCs require a large balloon payment or lump sum at the end
• Some HELOCs have fees, including an origination fee and closing costs
• Your monthly payment can vary — and even rise — based on the current HELOC rate and how much you borrow

Should you choose a HELOC or home equity loan?

If you want a fixed monthly interest rate and a fixed payment, and you know exactly how much money you need, a home equity loan is likely the best choice for you.

If you don't mind a variable interest rate and want to borrow as you go, a HELOC might be better. Just remember that your monthly payment might fluctuate as rates rise or you borrow more.

You should also consider the risk of borrowing from your home's equity, regardless of the type of loan you use. If you default on your second mortgage, the lender may foreclose and you could lose your house. Getting a home equity loan or HELOC isn't necessarily a bad idea, but it's important to consider what's at stake when you take out a loan on your home.