Quick overview

Home equity loans and HELOCs both let homeowners tap equity — the portion of your home’s value you own free of mortgage debt — but they behave very differently. A home equity loan delivers a lump sum and predictable monthly payments; a HELOC gives a credit line you can draw from as needed and usually carries a variable rate. Which is better depends on whether you need a one‑time payment or ongoing access and how comfortable you are with interest‑rate variability.

How each product works

  • Home equity loan (second mortgage): You borrow a fixed principal amount and repay it over a set term (often 5–20 years) at a fixed interest rate. The full loan is disbursed at closing.
  • HELOC (home equity line of credit): The lender approves a credit limit based on your equity and credit profile. During the draw period (commonly 5–10 years) you can borrow, repay, and borrow again. HELOCs typically have variable rates tied to an index (like the prime rate) plus a lender margin. After the draw period ends you enter repayment, which can significantly raise payments if the structure requires principal and interest.

In my practice working with homeowners over 15 years, I’ve seen HELOCs shine for phased renovation work and seasonal borrowing, while home equity loans are better when borrowers need a single, large, predictable payout for things like major remodeling or debt consolidation.

Costs and fees to expect

Both products carry closing costs and fees. Common items include:

  • Application fees and credit checks
  • Appraisal or valuation fees
  • Title search and recording fees
  • Origination or lender fees
  • Annual or inactivity fees (more common with HELOCs)
  • Early termination or closure fees in some plans

HELOCs can also have variable interest margins, periodic rate floors or caps, and sometimes interest‑only payment options during the draw period that lead to higher balances later. Home equity loans generally cost more up front for origination in exchange for a lower, fixed rate over time.

The Consumer Financial Protection Bureau (CFPB) has a clear overview of HELOC features, including variable rates and borrower protections — see CFPB guidance on home equity lines for details.

Interest rates and payment patterns

  • Fixed-rate home equity loan: predictable payments, easier to budget, less interest‑rate risk.
  • Variable-rate HELOC: initial rates may be lower but can rise when the underlying index moves. HELOCs sometimes offer an introductory rate.

Example: A borrower using a HELOC for a three-phase renovation may draw $20,000, repay some as work completes, and redraw later. That flexibility can reduce interest costs if they only carry balances for short periods. Conversely, a homeowner who needs $80,000 for a single project often pays less total interest with a fixed home equity loan because the rate is locked.

Loan-to-value, eligibility, and underwriting

Lenders base approval on the combined loan‑to‑value (CLTV) ratio: the balance of your first mortgage plus the new second mortgage (HELOC or home equity loan) divided by the home’s appraised value. Many lenders commonly allow CLTVs up to roughly 80–85% for standard programs; terms vary by lender and borrower creditworthiness.

Common eligibility criteria:

  • Sufficient equity (often at least 15–20%)
  • Steady income and employment history
  • Acceptable credit score; many prime offers target 680–720+ scores
  • Debt‑to‑income (DTI) ratio within lender limits

Underwriting may require proof of income, tax returns, and an appraisal. In my work, borrowers with solid credit and documentation get the most competitive margins and higher CLTV allowances.

Tax considerations (what the IRS says)

Under current federal tax rules, interest on a home equity loan or HELOC is deductible only if the loan proceeds are used to buy, build, or substantially improve the home that secures the loan. This restriction follows changes in the tax code and is explained by the IRS; see IRS Publication 936 and IRS guidance on mortgage interest for details.

Practical implications:

  • If you borrow to remodel your home, mortgage interest may be deductible (subject to limitations). Keep detailed records that show how borrowed funds were used.
  • If you use proceeds for personal expenses (vacation, debt unrelated to the home), interest generally is not deductible.

Always confirm current rules with the IRS or a tax professional before relying on deductions.

Risks to weigh

  • Secured by your home: default can lead to foreclosure. Treat both HELOCs and home equity loans as serious obligations.
  • Rate risk for HELOCs: rising rates increase monthly payments and total interest.
  • Payment shock after the draw period: HELOCs that allow interest‑only payments during draws may require large principal‑and‑interest payments later.
  • Overborrowing and reduced equity: tapping too much equity limits future refinancing or sale flexibility.

Common use cases and which fits best

  • Home equity loan: Best for one‑time, large expenses (major remodeling, single debt consolidation, medical bills). Choose this when you want payment certainty.
  • HELOC: Best for ongoing, uncertain costs (phased renovations, college tuition payments over years, seasonal cash flow). Good when you need flexibility and can tolerate variable rates.

Case study (realistic): A client needed $45,000 to replace a roof and upgrade HVAC. They chose a home equity loan to lock a 10‑year fixed payment and avoid rate volatility. Another client managing rental property repairs used a HELOC to draw as problems appeared, repaying between projects.

How to compare offers (step‑by‑step)

  1. Calculate how much you need and whether the expenses are one‑time or recurring.
  2. Get quotes for APR (home equity loan) and margin + index (HELOC). Ask for historical index behavior and rate cap structure.
  3. Compare total closing costs and ongoing fees.
  4. Run worst‑case scenarios for HELOCs: what happens if rates rise 3–4 percentage points? Can you still afford payments after the draw period?
  5. Ask about prepayment penalties, inactivity fees, and how the lender handles reductions in home value or CLTV breaches.
  6. Consider alternatives such as a cash‑out refinance, personal loan, or contractor financing; compare total costs and risks. (See our guide on Home Equity Alternatives for more.)

Practical tips and red flags

  • Tip: Keep documentation showing how HELOC/home equity loan proceeds are used if you plan to claim mortgage interest deductions.
  • Tip: Negotiate fees and ask about rate discounts for autopay or existing customers.
  • Red flag: Lenders that pressure you to borrow more than you need or promise unusually low teaser rates without clear caps.
  • Red flag: Promises of no appraisal or no documentation for large lines — these are often too good to be true.

FAQ highlights

  • Are HELOC payments interest‑only? Sometimes during the draw period; eventually most HELOCs require principal repayment.
  • Can I convert a HELOC to a fixed rate? Some lenders permit partial fixed‑rate conversions or offer a fixed‑rate second mortgage to replace a HELOC.
  • Will a HELOC affect my ability to refinance my first mortgage? Yes — active HELOCs that are open and drawn affect CLTV and refinancing options.

Where to learn more and next steps

Authoritative resources I recommend consulting before applying:

  • IRS — mortgage interest rules and Publication 936 (irs.gov)
  • Consumer Financial Protection Bureau — HELOC disclosures and borrower protections (consumerfinance.gov)

For practical, site‑specific guidance, read our related articles:

Professional disclaimer: This article is educational and does not constitute tax, legal, or financial advice. For personalized recommendations, consult a CPA, tax advisor, or certified financial planner who can analyze your full financial picture.

References

(Information current as of 2025.)