If you’ve built equity in your home and need cash, you’re usually looking at two contenders: a home equity loan (often called a “second mortgage”) or a home equity line of credit (HELOC). They both use your home as collateral, but they work—and fit different needs—very differently. Here’s a clear, decision-ready guide.
Quick Definitions
Before we go into the details about which option might be best for you, here is a quick refresher on what the terms mean:
- Home Equity Loan: A lump-sum loan with both a fixed interest rate and monthly payments over a set term (e.g., 5–20 years). It’s predictable and behaves like a traditional installment loan.
- HELOC: A revolving line of credit you can draw from as needed during a “draw period” (often 5–10 years). Payments during the draw are frequently interest-only; when the draw ends, you enter a repayment period where principal + interest is due, and the payment can jump. Most HELOCs have variable rates tied to an index (e.g., Prime).
How Each One Works
Now that you know what each one means, here is a breakdown of the funding, rates and payment structure for each one.
Home Equity Loan
- Funding: One lump sum at closing.
- Rate: Fixed.
- Payment: Equal monthly payments that fully amortize the balance by the end of the term—easy to budget.
HELOC
- Funding: Borrow only what you need, when you need it, up to your limit, during the draw period (often via checks or a card).
- Rate: Typically variable; lenders disclose the index (e.g., Prime, CMT) and your margin over that index. Some plans offer teaser rates, and a subset lets you convert portions of the balance to a fixed rate.
- Payment: During the draw, minimums can be interest-only or interest + a small principal portion. When the draw ends, you enter full repayment (commonly 10-15 years), or in some contracts, you may owe a balloon, so you must be ready.
How Much Can You Borrow?
Many lenders cap total borrowing around 85% of your total home’s value minus what you owe on the first mortgage (your “combined loan-to-value,” or CLTV). Exact limits vary by lender and your profile, but 85% is a common guideline cited by the National Credit Union Administration.
Quick example:
Home value $600,000; current mortgage $320,000.
85% of $600,000 = $510,000.
$510,000 – $320,000 = $190,000 potential borrowing room (subject to underwriting, fees, and product type).
Costs, Fees, and Fine Print
Both products can involve appraisal fees, application fees, and closing costs (title, recording, insurance, taxes). Some lenders waive parts of these; others don’t. HELOCs may also have annual fees, inactivity fees, or transaction fees. Don’t compare APRs alone; review the full fee schedule.
Right to rescind: Federal law generally gives you three days to cancel a HELOC after opening; fees must be refunded if you rescind on time.
Line freezes: Lenders can reduce or freeze a HELOC if your home value drops or your financial situation worsens. If that risk would disrupt your plans, factor it in.
Tax Treatment
Interest on home equity loans and HELOCs may be deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan, and subject to overall mortgage debt caps (commonly $750,000 post-2017 for most taxpayers). If you use proceeds for non-home purposes (e.g., paying off unrelated debt), interest is typically not deductible. See IRS Publication 936 for details.
Side-By-Side Comparison
| Feature | Home Equity Loan | HELOC |
| How you Receive Funds | One lump sum | Draw as needed up to the limit |
| Rate Type | Fixed | Usually variable (some fixed-rate convert options) |
| Payments During Initial Phase | Fully amortizing from day 1 | Often interest-only during draw |
| Payment Predictability | High | Lower during the draw, can jump at repayment |
| Best for | One-time, known cost (e.g., roof, debt payoff plan with fixed schedule) | Ongoing or phased needs (e.g., multi-stage renovation, tuition over several years) |
| Risk to Plan | Lower rate risk, but you pay interest on the full amount | Rate risk; possible line freeze; payment shock at the end of the draw |
Which is Right for You?
- You know the exact dollar amount and want a steady payment.
A home equity loan fits best. Fixed rate, fixed term, and a clear payoff path. - You’ll spend in phases or want flexibility.
A HELOC lets you draw gradually and only pay interest on what you use during the draw. Just plan for the variable rate and the higher payment later. - You want to keep one mortgage payment and tap a large sum.
Consider a cash-out refinance as an alternative, weighing total closing costs and your current first-mortgage rate.
Common Pitfalls to Avoid
- Underestimating payment shock. If you’ve been paying interest-only on a HELOC, your bill can rise sharply when principal kicks in or a balloon comes due. Read the schedule.
- Chasing teaser rates. Intro rates end. Know the index + margin, any caps/floors, and how often the rate can adjust.
- Ignoring line-freeze risk. If your project relies on future draws, a home-value drop could tighten or freeze your line.
- Assuming interest is deductible. It isn’t unless you use the funds to buy/build/improve the home, securing the loan, and you meet IRS limits.
A Simple Decision Framework
- Define the job to be done. Is your need a fixed, one-time cost or an ongoing/uncertain expense stream? Match the structure to the spend.
- Estimate your safe borrowing capacity. Use an 80–85% CLTV guideline for back-of-napkin math; then validate with a lender’s underwriting.
- Stress-test the payment. Model your worst-case HELOC rate using the margin + a high index assumption and ensure you can cover the post-draw payment (or balloon).
- Total the real cost. Include appraisals, title work, annual/transaction/inactivity fees (HELOC), and any early-termination fees. Don’t compare APRs alone.
- Check tax fit. If the project doesn’t “buy, build, or substantially improve” the home, don’t plan on an interest deduction.
- Plan contingencies. If a line freeze would derail your timeline, a home equity loan (or staged loan draws) might be safer.
Bottom line
- Choose a home equity loan if you value certainty: one check, fixed rate, fixed payments, and a clear end date.
- Choose a HELOC if you need flexibility over time and can handle rate changes and a bigger bill later.
- If neither fits cleanly, compare a cash-out refi—but only if replacing your first mortgage makes sense after costs.
Armed with these rules of thumb and the disclosures lenders must provide, you can match the product to your purpose, budget transparently, and protect your home equity as the asset it is.
You might also be interested in: Refinancing Loans: How It Works and When It’s Beneficial
