HELOC vs. Home Equity Loan: Which is the Better Option?

Not sure if a HELOC or home equity loan is right for you? Keep reading for our comparison between the two options.

Financial Planning
May 11, 2023
HELOC vs. Home Equity Loan: Which is the Better Option?

If you're looking to tap into the equity built up in your home, you've likely come across two popular options: HELOCs and home equity loans. These financing options allow you to borrow against the value of your home, but they have some key differences. We’ll explore the nuances between HELOCs and home equity loans, comparing their features, benefits, and potential drawbacks. 

To make an informed decision about which is best for your financial needs, you'll need to understand the distinctions between these two loan types. So, let's dive into the world of HELOCs vs. home equity loans and find out which one might be right for you.

Understanding HELOCS

A HELOC,or home equity line of credit, is a revolving line of credit that allows homeowners to borrow against the equity in their homes. Similar to a credit card, it has a predetermined credit limit and a variable interest rate. 

Homeowners can draw funds as needed during the draw period, typically 5-10 years, and are required to make interest-only payments during this period. Subsequently, a repayment period follows where the homeowner pays both principal and interest.1

Benefits of HELOCS

There are various benefits of HELOCs that homeowners may be attracted to. These include:

  1. Flexibility: HELOCs allow homeowners to borrow funds as needed during the draw period, making them suitable for ongoing or unpredictable expenses.
  2. Lower Initial Costs: HELOCs typically have lower upfront costs compared to home equity loans, as homeowners only pay interest on the borrowed amount during the draw period.
  3. Interest-Only Payments: During the draw period, homeowners can make interest-only payments, providing financial flexibility.

Potential Risks of HELOCs

Despite the benefits, there are still potential risks in choosing HELOCs to access equity. Before settling on a HELOC loan, consider the following:2

  1. Variable interest rates: HELOCs have variable interest rates that fluctuate over time. These can lead to varying monthly payments and potentially higher interest costs.
  2. Potential overspending: The accessibility of funds in a HELOC may tempt homeowners to overspend and accumulate excessive debt.
  3. Resetting of interest rates: After the draw period, the interest rate on a HELOC may reset, potentially increasing your monthly payment.

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Introduction to Home Equity Loans

In contrast, a home equity loan, also known as a second mortgage, provides a lump sum of money upfront. As the homeowner, you’ll receive the entire loan amount at once and pay it back over a fixed term with a fixed interest rate. Monthly payments include both principal and interest, offering predictability and stability.3

Advantages of Home Equity Loans

Home equity loans offer a number of benefits to homeowners looking to unlock their equity. These advantages include:

  1. Lump sum funding: Through a home equity loan, homeowners gain immediate access to a lump sum of money, making them suitable for one-time expenses such as home renovations or debt consolidation.
  2. Stability and predictability: With fixed interest rates and fixed payments, homeowners have a clear understanding of their financial obligations throughout the loan term.
  3. Potential tax deductions: Sometimes, homeowners may be eligible for tax deductions on the interest payment on their home equity loans.

Potential Risks of Home Equity Loans

Similar to HELOCs, home equity loans are not without their risks. Potential downsides include:4

  1. Higher upfront costs: Home equity loans typically have higher upfront costs, including closing costs and fees.
  2. Less flexibility: Unlike HELOCs, home equity loans provide a one-time lump sum, limiting flexibility for ongoing or unpredictable expenses.
  3. Risk of foreclosure: Late or missed payments on a home equity loan can lead to foreclosure, potentially putting the homeowner's property at risk.

Factors to Consider When Choosing Between HELOCs and Home Equity Loans

Since HELOCs and home equity loans offer different benefits, it’s important to consider what you’re looking for as a homeowner. To help weigh your options, evaluate your goals, the risks involved, and interest rates. 

Personal Financial Goals and Needs

When deciding what financial option is best for you, take into account what your goals are. Are you in need of regular access to funds or a single large payment to cover a specific expense? Analyzing your needs can help you in selecting the choice that best suits your goals.

Risk Tolerance and Flexibility

Evaluate your risk tolerance and ability to manage potential interest rate fluctuations. HELOCs carry the risk of variable interest rates, which may impact monthly payments. Home equity loans, with a fixed rate, provide more stability but may have higher initial costs.

Interest Rates

In order to make the most informed decision on your monthly payments, it’s important to consider the current interest rate landscape. If there’s a possibility of a substantial rise in the future, opting for a home equity loan with a set interest rate might be a safer choice.

Choosing the Right Option for You: Unlock Your Equity

Ultimately, it’s important to carefully consider your financial situation and goals before deciding between a HELOC loan and a home equity loan. 

While HELOCs and home equity loans are popular options for homeowners looking to access the equity in their homes, there is another alternative that may be a better fit for some: sale-leasebacks. 

Truehold's Sale-Leaseback allows you to sell your home at competitive price to unlock your equity. Then, you can live in the home you love as a renter and leave it to us to worry about any major home repairs or property insurance. With our sale-leaseback, you can avoid the potential pitfalls of HELOCs or home equity loans while still accessing your hard-earned cash. 

Learn more by speaking with one of our advisors today. 

Sources:

  1. Bank of America. What is a Home Equity Line of Credit. https://www.bankofamerica.com/mortgage/learn/what-is-a-home-equity-line-of-credit/ 
  2. Investopedia. 5 Ways a Home Equity Line of Credit (HELOC) Can Hurt You. https://www.investopedia.com/articles/mortgages-real-estate/11/helocs-can-hurt-you.asp 
  3. Federal Trade Commission: Consumer Advice. Home Equity Loans and Home Equity Lines of Credit. https://consumer.ftc.gov/articles/home-equity-loans-and-home-equity-lines-credit 
  4. Investopedia. What are the Risks of Taking Out a Home Equity Loan. https://www.investopedia.com/risks-of-home-equity-loan-5270566 
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