Has your mind been on home improvement or other significant expenses? Your home may be a financial goldmine just waiting to be tapped. The equity you’ve built up, which is the difference between what your home is worth and what you still owe on your mortgage, can be a powerful tool to help you achieve your goals. It can be ideal for remodeling your kitchen, paying for college tuition, or consolidating debt.
When you start looking into using your home’s equity, you’ll likely come across two main options: a fixed home equity loan and a Home Equity Line of Credit (HELOC). They might sound similar, but they’re different, each with its own set of strengths and weaknesses. A bit confused as to whether a home equity loan or a home equity line of credit (HELOC) will better fit your needs? Let’s review the differences to help you make a decision.
Your home’s equity is a powerful financial tool, and when you’re ready to tap into it, you have two main options: a fixed home equity loan and a home equity line of credit (HELOC). As with anything, you want to choose the right tool for the job. Do you need a large, one-time sum for a specific project, or would you prefer the flexibility of a credit card with a lower interest rate? Let’s break down these two options so you can make an informed choice.
What’s a Fixed Home Equity Loan?
Think of a fixed home equity loan as a second mortgage. When you get one, you receive a lump sum of cash all at once. It’s a one-and-done deal.
Imagine you’re planning a big kitchen renovation. You have the designs, the contractor is ready, and you know exactly how much you need, say, $35,000. This is the perfect scenario for a fixed home equity loan.
A home equity loan is a lump-sum, one-time loan. You apply for a specific amount, and if approved, the full amount is deposited into your account. Then, you start making regular, fixed monthly payments over a set period. The term is typically 5, 10, or even 20 years.
It’s similar to your original mortgage, but for a smaller amount and a shorter term. The most important thing to know about this type of loan is that the interest rate is fixed. Your monthly payment will never change, no matter what happens in the economy. It’s predictable and stable, which can be a welcome relief for those who prefer to budget with certainty.
Strengths of a Home Equity Loan
- Predictable Payments: Since the interest rate is fixed, your monthly payment remains consistent. This makes budgeting a breeze and protects you from rising interest rates.
- Structured Repayment: You receive all the funds upfront and have a clear repayment schedule in place. This can be great for staying disciplined and ensuring you pay off the debt on time.
- Disciplined Spending: Since you receive all the money upfront, you can plan accordingly. It encourages you to stick to a plan.
- Great for Large, Specific Expenses: If you have a clear, one-time need for a specific amount of money – like a major renovation, consolidating high-interest debt, or paying for a child’s college tuition – a fixed home equity loan is often the most straightforward choice.
Weaknesses of a Home Equity Loan
- Less Flexible: You get the money all at once, whether you need it or not. If your project costs less than you expected, you will still be left with the entire loan amount to pay off. You can’t take out a little bit here and there.
- Closing Costs: Just like a mortgage, a home equity loan typically incurs closing costs and fees.
- One and Done: If your project costs more than you anticipated or you need additional funds later on, you’ll have to go through the application process again for a new loan.
- Immediate Interest Accrual: You begin paying interest on the full loan amount from the very first day, even if you don’t need the entire amount immediately.
When to Use a Home Equity Loan
Think of the home equity loan as your “big project” tool. It’s best when you:
- Know the exact amount you need.
- Have a one-time, significant expense.
- Want the security of a fixed monthly payment.
- Are concerned about future interest rate hikes.
A home equity loan is ideal for larger expenses such as the following:
- The home remodeling project is being completed all at once
- Debt consolidation
- Vacation
- Medical expense
- Wedding expense
- College tuition
- Vacation home
- A large purchase
Scenario 1: The Dream Kitchen Renovation
You’ve been dreaming of a new kitchen. You’ve gotten bids from contractors, and you know the total cost will be around $45,000. With a fixed home equity loan, the entire $45,000 is provided to you in one lump sum. You can pay the contractor in full, have a predictable monthly payment for the next 10 years, and enjoy your new kitchen without worrying about rising interest rates.
Scenario 2: Consolidating High-Interest Debt
You have several credit card balances with high interest rates, and the monthly payments are unpredictable and stressful. You could use a fixed home equity loan to pay off all those cards at once. Debt consolidation simplifies your financial life by replacing multiple, high-interest payments with one single, lower-interest payment. You’ll know exactly how much you’re paying each month and when you’ll be debt-free.
What Is a Home Equity Line of Credit (HELOC)?
Think of a HELOC more like a credit card, but with a much lower interest rate and a higher credit limit. You’re approved for a maximum credit limit, but you don’t receive all the money at once. Instead, you have a “draw period” (usually 10 years) during which you can withdraw cash as needed, up to your approved limit. You only pay interest on the amount you’ve actually used.
The key difference here is the interest rate. A HELOC typically has an adjustable rate, meaning the interest rate can fluctuate over time based on market conditions. Meaning your minimum monthly payment can fluctuate.
If you’re a DIY enthusiast with a few projects on your list – a small deck expansion this spring, a new roof next year, and a bathroom remodel a year after that. You don’t know exactly when you’ll do these projects or how much they’ll cost. A home equity line of credit (HELOC) is the perfect solution for your needs.
A HELOC works similarly to a credit card, but with a significantly lower interest rate and using your home’s equity as collateral. This is where the name “line of credit” comes from – it’s a line you can draw from as needed, up to a specific limit. You only pay interest on the amount you actually use.
HELOCs typically have two phases:
- The Draw Period: This is typically a fixed time frame, often 10 years, during which you can withdraw funds as needed. During this time, you usually only make interest-only payments on the amount you’ve borrowed.
- The Repayment Period: After the draw period ends, you can no longer withdraw funds. You then begin making principal and interest payments on the outstanding balance, usually over a period of 15 or 20 years.
Strengths of a HELOC
- Greater Flexibility & Control: You can borrow what you need, when you need it, up to your credit limit. This is ideal for ongoing or unplanned expenses.
- Pay Only for What You Use: You’re not paying interest on the full approved amount, just on the portion you’ve borrowed. If you don’t use any of it, you pay nothing (though some HELOCs have a small annual fee, so be sure to check).
- Interest-Only Payments: During the draw period, you can make interest-only payments, which can keep your monthly costs low.
- Lower Initial Costs: HELOCs often have lower closing costs compared to home equity loans.
- Revolving Credit: Once you pay down the balance, the credit becomes available again, just like a credit card.
Weaknesses of a HELOC
- Variable Interest Rate: The most significant difference and potential risk. The interest rate on a HELOC is typically variable, meaning it can go up or down based on a market index. This means your monthly payments could increase over time, making budgeting more challenging.
- Potential for Overspending: With a line of credit available, there’s a temptation to use it for non-essential purchases, which could lead to overspending.
- Two-Part Repayment: Many HELOCs have a two-phase repayment structure. The draw period, where you might only be required to make interest-only payments, is followed by a repayment period, where you must pay both principal and interest. It’s crucial to understand how this transition will affect your budget. Benchmark FCU offers members two great repayment options for their Ultimate HELOC, making it a strength for many borrowers. Tap to see the differences in repayment for a Benchmark HELOC.
When to Use a HELOC
The HELOC is your “flexible project” tool. Those with larger expenses spread out over time may find the benefits of a HELOC much more appealing. When you apply for a home equity line of credit, you have access to an approved limit of cash, but you don’t need to pay any interest on the money until you start to withdraw it from the line. It’s great when you don’t need the funds all at once. Your payments are based on the balance you withdraw, rather than the total of your approved amount. The line allows you to draw funds when you need them. As you pay down the balance, you can continue to reuse the line for the entire draw period. There will be a pre-specified draw period and repayment period.
It’s ideal when you:
- Have a series of ongoing or unknown expenses.
- Want the flexibility to draw funds as you need them.
- Are comfortable with a variable interest rate.
- Want to use your home’s equity as an emergency fund.
A HELOC is ideal for borrowing needs, including:
- Home improvement projects spread out over time
- Ongoing educational expenses
- Consolidation of debt
- Emergency or unexpected expenses
- Large expenses
- A combination of different expenses
Scenario 1: Ongoing Home Repairs or Upgrades
Let’s say you have a few home projects you want to tackle over the next couple of years. Consider a new roof, a bathroom remodel, and new landscaping. You don’t want to take out three separate loans, and you don’t have a firm budget for all of them yet. A HELOC is perfect in this scenario. You can take out a small amount of money for the roof, pay it down, and then use the available credit for the bathroom and landscaping when you are ready. You only pay interest on the amount you’ve withdrawn.
Scenario 2: College Tuition Payments
Tuition payments happen on a semester-by-semester basis. Instead of taking out a large loan at the beginning, a HELOC allows you to withdraw funds as each semester’s bill comes due. You will only be paying interest on the funds you’ve actually used, which can save you a significant amount of money over time.
The Benchmark Comparison: Fixed Home Equity Loan vs. HELOC
Choosing between a fixed home equity loan and a HELOC comes down to a few key factors. Let’s break it down in a simple, side-by-side comparison:
| Feature | Fixed Home Equity Loan | Home Equity Line of Credit (HELOC) |
| Loan Type | Lump sum, one-time loan | Revolving line of credit |
| Interest Rate | Fixed | Variable (can change) |
| Payment Structure | Predictable, fixed monthly payments | Variable payments based on what you owe |
| Best For | One-time, large expenses | Ongoing, flexible expenses |
| Borrowing | All at once | As needed, up to your credit limit |
| Risk | Low interest rate risk | High interest rate risk |
Finding the Right Fit for You
Choosing the right option isn’t about one being “better” than the other; it’s about which one fits your specific needs and financial comfort level.
- Are you a planner who values stability? The fixed home equity loan might be your best bet. It’s secure, predictable, and perfect for when you have a clear plan.
- Are you someone who likes flexibility and is comfortable with change? The HELOC could be the perfect tool for you. It gives you the freedom to tackle projects on your own timeline.
The most important thing is to understand what you’re signing up for. Take the time to consider your project, your financial situation, and your personal risk tolerance. Don’t hesitate to ask questions and explore all your options.
Finding the best deal on a Home Equity Loan
No matter which option you choose, a fixed home equity loan or a HELOC, it’s smart to shop around for the best terms.. To compare apples to apples, you will want to know all the costs and fees involved in paying for the loan, in addition to the interest rate. The lowest interest rate does not always equal the best deal, especially when high fees are involved.
Here’s what to keep an eye out for:
- Interest Rates: While fixed rates offer stability, you still want the lowest one possible. For a HELOC, look at the initial “teaser” rate and the “index” rate it will adjust to.
- Fees: Ask about application fees, appraisal fees, and closing costs. Some lenders, such as your local credit union, may offer lower fees or even waive them entirely.
- Repayment Terms: For a fixed loan, understand the length of the repayment period. For a HELOC, ensure you understand the draw period, repayment period, and any potential interest-only payment options.
Tap to read the details of a Benchmark home equity loan vs. the ultimate flexibility of a Benchmark HELOC.
Your Credit Union Might Be Your Best Option
When you’re ready to explore your options, don’t overlook your local credit union. Unlike big banks, which focus on maximizing profits for shareholders, credit unions are non-profit financial cooperatives owned by their members. This difference in structure can lead to some significant advantages for you:
- Lower Rates and Fewer Fees
- Personalized Service
- Trust and Community Focus
Used responsibly, with a focus on making your monthly payment on time every month, a home equity loan or a HELOC can be a great financial tool in helping you realize your financial goals. When used irresponsibly, however, they can put your home in danger of foreclosure. Your house is, after all, the collateral for the loan. You must be sure you can make the payments before borrowing. You also want to avoid the temptation of using a HELOC for items you don’t need. That can quickly lead to financial trouble.
The equity in your home increases as you pay down your mortgage. It opens up the opportunity to use that equity to borrow and finance other expenses. Qualifications for home equity loans vary among lenders. In addition to having enough equity in your home, most lenders will also check your credit score, monthly income, and your debt-to-income ratio. Tap to learn more about Benchmark Federal Credit Union’s competitive rates on home equity loans and HELOCs. Ready to tap into your home’s equity? You can apply in person or online.
Read our blog, “The 5 Best Uses for Home Equity.”
Disclaimer
The information on this website is provided for general informational purposes only and is not intended as financial advice or a recommendation. It should not be relied upon for making financial decisions. We strongly advise consulting with a professional financial advisor before taking any action based on this content. We do not guarantee the accuracy, completeness, or usefulness of this information and will not be liable for any loss or damage resulting from your reliance on it. Use of this site constitutes acceptance of this disclaimer.