If you own a home and have paid down part of the mortgage, or the home has risen in value, you may be able to borrow against that equity. Equity is the difference between what the home is worth and what you still owe on it. The two main ways to tap it are a home equity loan and a home equity line of credit, known as a HELOC.
Key takeaways
- A home equity loan pays a lump sum at a usually fixed rate.
- A HELOC is a reusable credit line with a usually variable rate.
- Both are secured by your home, so borrow only for purposes worth that risk.
How a home equity loan works
A home equity loan gives you a lump sum at closing. It usually carries a fixed rate and equal monthly payments over a set term. Because it works like a second mortgage, the payment is predictable from start to finish.
It suits a single, clearly priced expense: a renovation with a contractor’s quote, a large medical bill or a one-time tuition payment.
How a HELOC works
A HELOC is a revolving credit line secured by your home. During the draw period, you can borrow as needed up to your limit, repay and borrow again. Many HELOCs let you pay only interest during this period.
When the draw period ends, the repayment period begins. You can no longer borrow, and payments now include principal, so they often rise sharply. Most HELOCs have variable rates, so the payment can also change with the market.
Side-by-side comparison
| Home equity loan | HELOC | |
|---|---|---|
| How you receive money | Lump sum at closing | Draw as needed |
| Rate type | Usually fixed | Usually variable |
| Payments | Fixed from the start | Can be interest-only at first, then rise |
| Interest charged on | The full amount | Only what you have drawn |
| Best for | One known cost | Ongoing or uncertain costs |
Costs and risks to check
- Closing costs, appraisal fees and any annual or inactivity fees.
- Minimum draw amounts and early closure fees on a HELOC.
- How much of your equity the lender allows you to borrow in total.
- The payment you will face when a HELOC moves from draw to repayment.
Tip: Both loans are secured by your home. If you cannot repay, you could lose it. Borrow for purposes that justify that level of risk.
How much you can borrow
Lenders usually cap the total of your mortgage and the new equity loan at a share of the home’s appraised value. That cap is called the combined loan-to-value limit. For example, if a lender allows a combined limit of 80 percent on a home appraised at 400,000 dollars, your mortgage and equity loan together could not exceed 320,000 dollars. The exact limit varies by lender and borrower, so treat these numbers as an illustration only.
Beyond equity, lenders review your credit, income and existing debt payments, much as they did for your first mortgage.
How to compare offers step by step
- Ask each lender for the rate, whether it is fixed or variable, and the index a variable rate follows.
- List closing costs, appraisal fees, annual fees and any early closure fees.
- For a HELOC, confirm the length of the draw and repayment periods and the payment in each.
- Check whether a HELOC allows you to fix the rate on part of the balance.
- Compare the total expected cost for the way you actually plan to use the money.
Mistakes to avoid
Treating a HELOC like a checking account is the most common trap. Small draws add up, and interest-only payments can hide how large the balance has grown until repayment begins. Another mistake is borrowing the maximum available because the lender approved it. Only borrow what the project needs, and keep a cushion of equity in case home values fall.
Common questions
Is the interest tax deductible?
In some cases, interest may be deductible when the money is used to buy, build or substantially improve the home that secures the loan. Rules change and depend on your situation, so check with a tax professional.
Can I use home equity to pay off credit cards?
You can, but it turns unsecured debt into debt backed by your house. Weigh the alternatives in debt consolidation first.
Can I pay off a HELOC early?
Usually yes, but some lenders charge a fee if you close the line within the first few years. Check the agreement before you open it.
What happens if my home loses value?
If values fall, you may owe more than the home is worth, and a lender can freeze or reduce an open HELOC. Keeping some equity untouched gives you a buffer.
For the main mortgage decision, see fixed vs. adjustable rate mortgages.