HELOC or home equity loan: the basics

Home equity loans and home equity lines of credit both let you borrow against the value of your home. They work differently, though, and the differences show up in your monthly budget. Here's how each one works, how they compare, and what to ask a lender. It's general information, not financial advice.

The CFPB puts it simply. A home equity loan is a specific amount of money borrowed against your home's equity, paid out in a lump sum. A HELOC is a line of credit, like a credit card, except you're borrowing against your home. If you already have a mortgage, either one would be a second mortgage with its own payment.¹

Not sure how much equity you have? Our guide to what home equity is walks through the math.

How a home equity loan works

With a home equity loan, you borrow a set amount and usually get it all up front. The FTC says these loans typically have a fixed rate and are repaid in equal monthly payments over a fixed term.²

The appeal is predictability. With a fixed rate, you know the payment from the start. The trade-off, as the CFPB's HELOC booklet notes, is that if you need more money later, you'd have to apply for a new loan.³

One variation to know about is the interest-only loan. The FTC explains that the payments cover only interest, so the principal isn't paid down. A lump sum, or balloon payment, is usually due at the end, and it's often large because it includes the unpaid principal.²

How a HELOC works

A HELOC gives you a credit limit you can draw from as needed. You make payments only on what you borrow, not on the full amount available.² Many HELOCs have two stages:

• The draw period. You can borrow up to your limit, typically with special checks or a card. The CFPB says this stage could last 10 years, for example. Some plans let you pay only interest during this time.⁴²
• The repayment period. You can't borrow anymore. The CFPB says the lender may set a schedule to repay the full balance, often over 10 or 20 years, and that monthly payments are often significantly higher once repayment starts. In some cases, the whole balance is due as soon as repayment begins.⁴

HELOCs usually have variable rates, so your payment can change even if you don't borrow more. Some let you convert part or all of the balance to a fixed rate, which is usually higher but more predictable.⁴³

Lenders can also freeze or reduce a HELOC. The FTC gives two examples: the home's value drops significantly below the appraised amount, or the lender reasonably believes a major change in your finances means you won't be able to make the payments.²

Side by side

• How you get the money. A loan pays a lump sum. A HELOC lets you draw as needed, up to a limit.¹
• Rate. Loans usually have a fixed rate. HELOCs usually have a variable one.²
• Payments. A loan's payment is usually the same each month. A HELOC's payment depends on the balance and the rate, and it can rise when repayment begins.²⁴
• What's at stake. Both are secured by your home.²

Questions to ask a lender

The CFPB's HELOC booklet suggests getting three estimates and comparing them side by side. Many of the same questions apply to a home equity loan:³

• What is the rate, and is it fixed or variable? If it varies, what index is it tied to, how often can it change, and is there a cap?
• Is there an introductory rate, and what happens when it ends?
• What are the upfront costs, such as an appraisal, an application fee, points, and closing costs?
• Are there annual fees, transaction fees, inactivity fees, or a fee for closing the account early?
• How long are the draw and repayment periods, and could a balloon payment come due?
• Is there a minimum amount I have to draw or keep outstanding?

Lenders have to disclose a HELOC's costs and terms, in most cases when they give you an application. That makes it easier to compare offers on paper.²

Before and after you sign

Read the closing papers carefully. The FTC's advice is direct: if the financing isn't what you expected or wanted, don't sign. You can negotiate changes or turn the offer down.²

If you're using your main home as collateral, federal rules generally give you three business days to cancel a home equity loan or HELOC for any reason, without penalty. You have to cancel in writing. There are exceptions, and the right doesn't apply to a vacation or second home.²³

The FTC also warns about a closing scam: an unexpected email, supposedly from your loan officer, asking you to wire closing costs to a different account. Contact your lender at a number or email address you know is real.²

The FTC suggests talking with an attorney, a financial advisor, or someone else you trust before making any decision.² Lenders also have to give you a list of HUD-approved housing counselors in your area, who can explain how HELOCs work.³

Thinking about borrowing against your home?

Home equity loans and lines of credit are secured by your home. Compare the costs and terms before you borrow.

See home equity options