If you own a home with equity built up, two products let you borrow against it: a home equity loan and a home equity line of credit (HELOC). Both use your home as collateral, but they work differently and suit different borrowing needs. Using the wrong one for your situation costs money unnecessarily.
What Is Home Equity
Home equity is the difference between your home’s current market value and your outstanding mortgage balance. If your home is worth $400,000 and you owe $250,000, your equity is $150,000. Lenders typically allow you to borrow up to 80–85% of your home’s value minus the first mortgage balance — your combined loan-to-value (CLTV) limit.
In the example above: $400,000 × 85% = $340,000. Minus the $250,000 first mortgage = $90,000 maximum available to borrow.
Home Equity Loan
A home equity loan is a lump-sum loan with a fixed interest rate and fixed monthly payments over a set term (typically 5–30 years). It functions like a second mortgage.
When it makes sense: You have a specific, one-time expense — a home renovation project, debt consolidation, a major purchase — where you know exactly how much you need.
Advantages:
- Fixed rate and payment — predictable for budgeting
- Full amount disbursed upfront
- Not affected by future rate changes
Disadvantages:
- Inflexible — you borrow all at once, even if you end up not needing part of it
- Interest begins immediately on the full amount
Home Equity Line of Credit (HELOC)
A HELOC is a revolving credit line — similar to a credit card — secured by your home. You can draw from it, repay, and draw again during the draw period (typically 10 years). After the draw period ends, you enter the repayment period (typically 10–20 years) where draws are no longer available and you repay the outstanding balance.
HELOCs typically have variable interest rates tied to the prime rate plus a margin. Rates can change monthly.
When it makes sense: Ongoing or uncertain expenses — a multi-phase renovation, a business with variable cash flow needs, or costs that will be spread over several years.
Advantages:
- Flexible — draw only what you need, when you need it
- Pay interest only on what you’ve drawn (during draw period on interest-only plans)
- Reusable as you repay
Disadvantages:
- Variable rate — payment can increase as rates rise
- Draw period discipline required — easy to keep drawing without reducing balance
- Potential for “payment shock” when draw period ends and full repayment begins
Rates and Costs
Both products typically have lower rates than credit cards or personal loans because they’re secured by real property. Closing costs for both are similar: appraisal, origination fees, title work — often $2,000–$5,000 total, though some lenders offer minimal-fee products.
Home equity loans lock in a rate at closing. HELOCs have an initial rate that adjusts. In a rising rate environment, a fixed home equity loan has a rate advantage; in a stable or falling rate environment, the HELOC’s potential flexibility may be preferable.
Tax Considerations
Interest on home equity loans and HELOCs may be deductible if the funds are used to buy, build, or substantially improve the home securing the loan. Interest used for other purposes (debt consolidation, consumer purchases) is generally not deductible under current tax law. Consult a tax professional before assuming deductibility.
The Core Risk
Your home is the collateral. If you default on a home equity loan or HELOC, the lender can foreclose. This risk makes using home equity for non-essential or speculative purposes particularly dangerous. Both products are most appropriate for investments in the property itself or consolidating high-cost debt with a concrete repayment plan.
For a single known expense, the home equity loan’s fixed terms are simpler and lower-risk. For ongoing or uncertain costs where you need flexibility, a HELOC provides that — at the cost of variable rate exposure and the discipline to not over-draw.
