A home equity line of credit (HELOC) and a home equity loan both let you borrow against the equity in your home as a second mortgage, without touching the rate on your existing first mortgage. They differ in how you receive the money and how the rate works.
HELOC
- A revolving line of credit. You are approved for a limit and draw what you need, when you need it, usually by transfer or check.
- Draw period, then repayment. Typically you can draw for 10 years, paying interest on what you have used, followed by a repayment period of 10 to 20 years when the balance amortizes and payments rise.
- Variable rate. Most HELOCs float with the prime rate plus a margin, so the payment can change. Some lenders offer a fixed-rate option on part of the balance.
- Low upfront costs. Many HELOCs have little or no closing cost, sometimes with an early-closure fee if you close the line within the first few years.
Home equity loan
- A lump sum paid at closing, with a fixed rate and a fixed monthly payment over a set term, commonly 10 to 30 years.
- Good when you know the amount you need and want payment certainty.
Which one, and when
- Projects paid in stages, such as a renovation: usually a HELOC.
- One known cost, such as paying off a specific debt: usually a home equity loan.
- If your current first-mortgage rate is low, either is usually cheaper than a cash-out refinance, which would replace that rate.
What lenders look for
Combined loan-to-value, meaning your first mortgage plus the new line, usually up to 80% to 90% of the home's value; credit score; and debt-to-income ratio calculated on the full line amount. Expect an appraisal or automated valuation, and income documentation.
Things to keep in mind
- Your home secures the line. Missing payments puts it at risk.
- A variable rate can rise. Ask what the lifetime cap is and what the payment would be at that cap.
- Whether the interest is tax-deductible depends on how you use the funds. Ask your tax advisor.