If you’ve built up equity in your home, you can borrow against it — often at lower interest rates than credit cards or personal loans. Two common options: a home equity loan, which gives you a lump sum at a fixed rate, and a HELOC (home equity line of credit), which works more like a credit card with a variable rate.
Both use your home as collateral. Both have their place. Which one makes sense depends on what you need the money for and how you prefer to manage debt.
What Is a Home Equity Loan?
A home equity loan lets you borrow a fixed amount against your home’s equity, receive the funds as a lump sum, and repay it over a set term — typically 5 to 30 years — at a fixed interest rate.
Key features:
- Fixed interest rate — your payment stays the same every month
- Lump sum disbursement — you get all the money at once
- Fixed repayment schedule — predictable payments, no surprises
- Closing costs typically apply (usually 2–5% of the loan amount)
Home equity loans are sometimes called “second mortgages” because they sit behind your primary mortgage in terms of payment priority.
What Is a HELOC?
A HELOC is a revolving line of credit — like a credit card — that you draw from as needed during a set draw period (typically 10 years). You only pay interest on the amount you’ve actually borrowed, not the full credit limit.
Key features:
- Variable interest rate — your rate (and payment) can change as market rates rise or fall
- Draw as needed — borrow $5,000 now, another $10,000 next year
- Draw period followed by repayment period — often 10 years to draw, then 20 years to repay
- Interest-only payments are common during the draw period
- Lower initial closing costs than a home equity loan (sometimes none)
HELOCs typically have variable rates tied to the prime rate, meaning your payment can increase significantly if interest rates rise.
How Much Can You Borrow?
Lenders typically allow you to borrow up to 80–85% of your home’s appraised value, minus what you still owe on your mortgage. This is called your combined loan-to-value (CLTV) ratio.
Example: Home worth $350,000. Mortgage balance: $200,000. 85% of $350,000 = $297,500. Minus $200,000 = $97,500 you could potentially borrow.
Lenders also evaluate your credit score, income, and debt-to-income ratio. Strong credit (typically 680+) gets you better rates.
When a Home Equity Loan Makes More Sense
- You need a specific amount for a one-time expense (home renovation, paying off high-interest debt, major purchase)
- You want payment certainty — a fixed rate and fixed monthly payment
- You’re in a rising interest rate environment and want to lock in your rate
- You prefer the discipline of a structured repayment schedule
When a HELOC Makes More Sense
- You have ongoing or unpredictable expenses over time (a multi-phase renovation, college tuition over several years)
- You want a financial safety net you can draw on when needed
- You plan to pay off the balance quickly and want flexibility
- Interest rates are stable or falling — variable rates carry less risk
Risks to Understand
Both options use your home as collateral. If you can’t make payments, the lender can foreclose. This is a fundamentally different risk than defaulting on a credit card.
Additional risks:
- HELOC rate increases: If the prime rate rises significantly, your monthly payment can jump. Some HELOCs cap the lifetime rate increase, but it can still be substantial.
- Payment shock on HELOCs: When the draw period ends, you enter full repayment — which means paying both principal and interest on whatever you borrowed. This can double your monthly payment if you’ve only been paying interest.
- Equity erosion: Borrowing against your home reduces the equity cushion that protects you if home values fall.
- Overborrowing: Easy access to credit (especially with a HELOC) can lead to borrowing more than is wise.
Tax Deductibility
Interest on home equity loans and HELOCs may be tax-deductible — but only if the funds are used to “buy, build, or substantially improve” the home securing the loan. Using the money to pay off credit cards or take a vacation does not qualify.
The total mortgage debt eligible for deductible interest is capped at $750,000 (for loans taken out after December 15, 2017). Consult a tax professional if you’re unsure whether your use qualifies.
How to Apply
The application process is similar for both:
- Check your credit score and review your credit report for errors
- Calculate your estimated equity (home value minus mortgage balance)
- Compare offers from your current lender and at least two others — rates and fees vary
- Submit an application with income documentation, tax returns, and property information
- The lender will order an appraisal
- Review the loan terms carefully before closing