HELOAN vs. HELOC: What Is the Difference?

Homeowners can borrow against their home equity to pay for renovations, consolidate debt, or cover other expenses. While both home equity loans (HELOANs) and home equity lines of credit (HELOCs) are financing options secured with your home, there are key differences to consider.

Deciding between a HELOC vs. HELOAN? Read on for how these two financing options compare, including their borrowing requirements, repayment structure, and the potential advantages and risks for each.

What Is a HELOAN?

A home equity loan, or HELOAN, is a type of financing that gives homeowners a lump sum that’s secured by their home, which is why these loans are considered second mortgages. With a HELOAN, you can typically borrow up to 80-85% of your home equity. Lenders calculate home equity as the difference between a property’s market value and the remaining mortgage principal.

HELOAN repayment generally begins as soon as funds are disbursed and involves fixed monthly payments over the loan term, which could be anywhere from five to 30 years. But unlike a mortgage, borrowers have flexibility in using these funds for a variety of expenses or financial goals.

Keep in mind that missing payments and defaulting on a HELOAN can result in foreclosure.

What Is a HELOC?

Like a home equity loan, a HELOC is secured using a home as collateral. But what is a HELOC and how does it work?

A HELOC gives homeowners a revolving line of credit that they can borrow from up to a fixed amount. HELOCs are typically capped at 90% of your home equity, but how much you qualify for also depends on your creditworthiness and financial situation.

Funds can be taken out as needed throughout a draw period lasting five to 10 years, with borrowers only required to make interest payments during this timeframe. Afterward, borrowing ends and the borrower begins making monthly payments that include both principal and interest for a repayment period of 10 to 20 years.

HELOAN vs. HELOC: Key Differences

We’ve covered the essentials of both home equity financing options. Now here’s a closer look at the main distinctions between a HELOC vs. HELOAN.

Loan Structure and Fund Access

Although both HELOCs and HELOANs let you tap into your home equity, they function differently when it comes to how funds are accessed.

When you take out a HELOAN, funds are disbursed as a one-time lump sum upon closing. This makes HELOANs ideal for financing expenses with a known cost, whether you’re putting a new addition on your home or consolidating high-interest debt.

Meanwhile, a HELOC works as a revolving line of credit. Like a credit card, HELOCs have a credit limit that can be borrowed against as needed. Borrowers can make multiple withdrawals throughout the draw period and are not required to use the full credit limit. This can make HELOCs ideal for ongoing expenses with fluctuating timelines, such as intermittent home renovations or medical expenses.

Interest Rates and Repayment

It’s also important to highlight how interest rates and repayment differ in our HELOAN vs. HELOC comparison.

HELOCs often have variable interest rates that are tied to the prime rate, meaning that your rate could go up or down based on market conditions. Lenders may offer the option to lock in your interest rate, even if you started with a variable-rate HELOC.

In either case, repayment on a HELOC begins as soon as funds are taken out, though monthly payments are initially limited to the interest on what’s been withdrawn. You can get an idea of what interest-only payments look like with a HELOC interest calculator. But once the draw period ends — usually after 10 years — borrowers are on the hook for repaying both interest and principal. Borrowers who aren’t prepared could find the jump in monthly costs to be a rude awakening.

HELOANs, on the other hand, generally have fixed interest rates vs. variable interest rates. Repayment typically begins immediately with fixed monthly installments over the loan term, which, as noted above, can range from 5 to 30 years.

Keep in mind that interest paid on either a HELOAN or HELOC may be tax deductible if the borrowed funds are used to buy, build, or substantially improve a home. A tax advisor can help you parse the details and follow changing tax regulations.

Recommended: What Happens to a HELOC When You Sell?

When to Choose a HELOAN vs. a HELOC

Whether a HELOC or home equity loan better suits your needs depends on several factors. Here are some scenarios to help decide between a HELOAN vs. HELOC:

If you have a large, known expense like a roof replacement or emergency medical bill, borrowing exactly the amount you need with a home equity loan could be a better fit. Monthly payments on the loan principal and interest begin in full right away but because they are a fixed amount, long-term budgeting may be easier.

For less predictable expenses, such as a gut renovation of a home, the flexibility of a HELOC to withdraw funds as needed could be more advantageous. Plus, the smaller interest-only payments with a HELOC during the draw period can prove helpful when budgets are tight and costs are ongoing.

Personal preferences can also play a factor. For instance, HELOCs usually have variable interest rates and not everyone is as comfortable with the uncertainty of fluctuating payments.

Risks and Costs to Consider

HELOCs and HELOANs come with costs and potential financial risks. For example, both involve using a home as collateral, so borrowers risk losing their home in foreclosure if they are unable to make monthly payments.

A HELOC or home equity loan comes with costs, including an appraisal, attorney fees, and origination fees. Closing costs usually range from 2% to 5% of the loan amount or total line of credit, though HELOCs waive closing costs but may have annual fees. Note that some lenders charge early termination fees if the HELOC or HELOAN is paid off years ahead of schedule.

Recommended: Cash-Out Refinance

The Takeaway

Home equity loans and HELOCs differ in their structure, including repayment, interest rates, and how funds are accessed. Thus, choosing between a home equity line of credit vs. home equity loan involves multiple considerations, including the type of expense, your financial situation, and personal preferences. Once you’ve decided on your preferred option, seek out rates from several lenders and explore their terms and fees to find the relationship that is right for you.

SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $350,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.

FAQ

How much equity do you need for a HELOC vs. HELOAN?

You generally need at least 15% to 20% equity in your home to qualify for either a HELOAN or HELOC. To determine your eligibility, you can calculate your loan-to-value (LTV) ratio by dividing the mortgage balance by the current value of your home. Homeowners with a LTV ratio of 85% would have 15% home equity and potentially qualify for a HELOAN or HELOC.

Can you have both a HELOAN and a HELOC at the same time?

You can have both a HELOAN and a HELOC simultaneously if you have enough home equity. Keep in mind that lenders typically limit borrowing to 80% to 85% of your home equity, which is your home’s current value minus the remaining mortgage balance.

Which is easier to qualify for, a HELOAN or a HELOC?

A HELOAN can be easier to qualify for because HELOCs may require a stronger credit score due to the higher risk of variable interest rates. When deciding between a home equity line of credit vs. home equity loan, this is an important consideration.

Do HELOANs and HELOCs have closing costs?

Both HELOANs and HELOCs have closing costs, which can be up to 2% to 5% of the loan amount or credit limit. Some HELOC lenders waive closing costs but may charge other fees such as early repayment fees. Upfront fees include appraisals and origination fees. Lenders may give borrowers the option to roll their closing costs into the monthly payment, but keep in mind that this adds interest that will need to be repaid later.

What happens to a HELOAN or HELOC if you sell your home?

A HELOAN or HELOC needs to be paid in full when you sell your home, as it cannot be transferred to a new home. Generally, the proceeds from the property sale are paid directly to the lender and the account is closed. Possible complications could arise if the lender has early repayment penalties or if the home sells for less than the combined balance of a first mortgage and a HELOC or HELOAN.

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Photo credit: iStock/mohdizzuan

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