How to turn your home’s value into cash with HELOCs and home-equity loans
Buying a home is one of the biggest purchases people make. Ideally, it’s an asset that can grow in value over time, and homeowners can tap that equity to make other purchases—or make a profit if they later sell their homes.
Home-equity loans and home-equity lines of credit (HELOCs) are two financial products that can turn your house’s value into cash. The two aren’t interchangeable, though.
In fact, home-equity loans and HELOCs vary quite a bit—in interest rates, how they’re repaid, and even how you receive your funds.
- Home-equity loans vs. HELOCs
- What is a home-equity loan?
- How home-equity loans work
- Pros and cons of home-equity loans
- What is a HELOC?
- How HELOCs work
- Pros and cons of HELOCs
- Choosing between a home-equity loan and a HELOC
Home-equity loans vs. HELOCs
Both home-equity loans and HELOCs allow you to leverage the value of your house.
With a home-equity loan, you take out a loan against the equity (essentially the amount of mortgage you’ve already paid off) and get a lump-sum payment in return. You’ll repay that amount through monthly payments, usually within a period of five to 30 years.
A HELOC, on the other hand, is a line of credit based on your home equity. You can withdraw funds from it—and repay them—many times over an extended period.
“Both choices have great benefits,” says Kyle Enright, president of Achieve Loans at Achieve. “However, deciding on whether to get a HELOC or home-equity loan will depend on your specific financial situation.”
Here’s a quick look at how these two products measure up:
These are just the basics of home-equity loans and HELOCs. We’ll go into more depth on each product below.
What is a home-equity loan?
A home-equity loan is a type of second mortgage that allows you to borrow from your home equity—the difference between your home’s value and the balance on your current mortgage.
You can use the proceeds from a home-equity loan for anything. For some homeowners, this type of loan may be a smart way to fund home repairs or even pay off debts, as they typically have lower interest rates than other financial products, such as credit cards.
“Depending on your personal financial situation, you can use a home-equity loan for many different reasons, including home improvements, debt consolidation, emergency funds, and other large life expenses—from education to business ventures,” says Rob Heck, vice president of mortgage at Morty, an online mortgage marketplace. “If you’re using a home-equity loan for home improvements, these renovations could potentially increase the value of your home, and the interest may also be tax-deductible.”
How home-equity loans work
With a home-equity loan, you borrow against your house. Depending on the lender, you may be able to borrow up to anywhere from 80% to 90% of your home’s value—minus any balance on your existing mortgage.
“Borrowers receive the money in a lump-sum payment and typically have a fixed interest rate, repaying the loan in fixed installments over a predetermined period of time,” Heck says.
To qualify for a home-equity loan, you’ll need to meet several requirements, including…
- Credit score: 620 or higher (though 700 or higher is preferred)
- Maximum loan-to-value ratio (LTV): 90% or lower
- Maximum debt-to-income ratio (DTI): 45% or lower
Eligibility requirements can vary by company, so you should shop around if you’re worried about qualifying. It’s possible you may qualify with one lender and not another.
Pros and cons of home-equity loans
Home-equity loans offer quite a few advantages. First, they give you access to potentially large sums of money you can use for any purpose. If your home is worth $500,000, for example, and you have only $100,000 remaining on your existing mortgage, you could presumably borrow up to $350,000 from your home’s equity.
Additionally, home-equity loans generally offer fixed interest rates, which means you’ll have a consistent payment for the entire loan term.
“The primary reason for selecting a home-equity loan is knowing that your monthly payments will be steady—set at a fixed interest rate for a fixed period of time—and that your interest rate is almost certain to be lower than many other common forms of debt, like credit cards,” says Cameron Findlay, chief economist at AmeriSave Mortgage Corp.
The interest you pay on home-equity loans may also be tax-deductible for the first $750,000 for single filers ($375,000 if married filing separately). To qualify for this deduction, you must use the funds to “buy, build, or substantially improve your home” and itemize your returns, according to the IRS.
There are downsides to home-equity loans, too. For one, they use your home as collateral, which puts it at risk of foreclosure if you stop making payments. There’s also the chance home values fall, which may mean owing more on your home than what it’s worth.
Home-equity loans also don’t provide a constant source of funds like HELOCs do, and there’s the chance you could borrow more than you actually end up using. This would result in more interest costs than necessary.
As Findlay cautions, “Home-equity loan borrowers should be careful not to borrow more than they need.”
What is a HELOC?
A HELOC—which stands for home-equity line of credit—also lets you borrow from your home equity, only this time with a credit line you can pull from as needed. This line of credit works much like credit cards do, allowing you to withdraw funds, repay them, and use them again whenever you need it.
For example, if you have a $20,000 line, you can withdraw $10,000 of it. Three months later, you can pull another $5,000, and so forth—until you’ve reached the $20,000 limit. HELOCs can be a good choice if you need access to cash over a long period of time, or if you’re unsure how much you need—for a home renovation project, for example.
How HELOCs work
With HELOCs, you can usually borrow up to 80% to 90% of your home’s value, less any mortgage balances currently on the property. So, if your home is worth $300,000 and you have a $200,000 mortgage balance, you could potentially qualify for a $70,000 line of credit.
Once you have the HELOC, you can withdraw money as needed throughout your “draw period,” which usually lasts five to 10 years. During that time, you’ll make interest-only payments to your lender.
“With HELOCs, the interest is applied only to the amount you actually withdraw—not the total value available in your credit line,” Findlay adds.
After your draw period ends, you’ll enter the repayment period. This is when you’ll make monthly principal and interest payments to your lender. These payments are not set in stone. Because HELOCs typically come with variable interest rates—meaning rates that adjust regularly—your payments can rise or fall as a result, which can make it harder to budget.
Some HELOCs also require a balloon payment once your draw period ends. So unlike credit cards, your full balance could be due all at once.
To qualify for a HELOC, you’ll need to meet a number of requirements, including…
- Credit score: 640 (though 700 or higher is preferred)
- Maximum loan-to-value ratio (LTV): 90% or lower
- Maximum debt-to-income ratio (DTI): 50% or lower
Keep in mind that these are just generalities. Lenders may have stricter qualifying requirements, so be sure to shop around.
Pros and cons of HELOCs
Much like home-equity loans or any other financial product, HELOCs have both pros and cons to consider.
One of the biggest perks of HELOCs is the flexibility it offers in accessing any amount of money as needed. This can be helpful if you require continued funds or you’re just not sure how much a project, expense, or medical treatment may cost you.
Also, you won’t pay interest on any more than you withdraw. With a home-equity loan, you’ll pay interest on the entire lump sum, whether or not you use it all. But HELOCs give you more control over the amount you borrow—and thus how much interest you’ll end up paying.
For example, if you took out a home-equity loan for $100,000, you’d pay interest on that entire $100,000 sum—even if you only used $50,000 of it. But if you had a $100,000 HELOC and used only $50,000 of it, you’d pay interest on just the $50,000 you borrowed.
Another benefit of HELOCs is that the interest you pay may be tax-deductible. As with home-equity loans, though, you’ll need to use the money toward improving your home if you want to qualify.
In terms of downsides, HELOCs usually charge variable interest rates, which can mean your payments are unpredictable. And if you borrow large sums of money, this could be dangerous for your budget.
“The consumer should understand that if they’re borrowing a lot of money, then the risk of that payment adjusting is a lot more,” says Jeremy Drobeck, a mortgage loan originator at Amerifirst Home Mortgage. “If you pull $80,000, the payment’s going to adjust a lot more when the rate adjusts versus if you pull $10,000.”
HELOCs, like home-equity loans, put your home at risk of foreclosure if you don’t make payments. They can also charge a number of ongoing fees.
“Read the fine print and watch out for hidden fees,” Enright says. “Some lenders charge an early termination fee. Others may charge additional fees if you don’t maintain a minimum loan balance or fail to borrow a certain amount each year.”
How to choose between a home-equity loan and a HELOC
Both home-equity loans and HELOCs can give you funds when you need them. Typically, if you need long-term access to cash, a HELOC is the better choice, while you may be better served by a home-equity loan if you need cash for a big one-time expense.
You should also consider how a fixed rate versus a variable rate could impact your finances.
“The benefit of a home-equity loan is its predictability,” Enright says. “These loans typically have a fixed interest rate for the life of the loan and a fixed monthly payment, making them easier to incorporate into a monthly budget. A HELOC is a better option if you want the flexibility to borrow as little or as much as you want, when you want.”
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