Should I Choose a HELOC or a Home Equity Loan?

Whether a HELOC or Home Equity Loan is right for you will depend in part on what you are planning to use the money for.

A home equity loan is similar to a fixed-rate mortgage loan. Home equity loans require you to make a fixed monthly payment over a period of time, and you will receive a set amount of money up front. Because the rate is fixed, a home equity loan is typically more costly initially, and the starting interest rate will be higher than the rate you would initially pay for a HELOC. If you know exactly how much money you will need up front for a one-time, significant expense, such as for a particular project or debt, then a home equity loan can be right for you.

A HELOC, in contrast, will be more flexible and allow you to pay a number of different expenses as they occur. You should consider a HELOC when you have numerous different expenses and are not sure what the total cost will be. A HELOC is also useful because you can just make interest payments for a period of time, plus a small annual fee, to open and maintain the line of credit before you draw on that credit. The principal will not come due until you start spending, and even then, you will only be responsible for what you spend.

A HELOC is also useful for periodic expenses, such as college tuition payments; you can contribute what you can from your own income and savings to help pay for these costs, and draw on the HELOC to cover the rest. However, because a HELOC's rates are adjustable, your monthly costs can increase, sometimes quickly. The cost of a HELOC may be higher over a longer period than a home equity loan would be.

Thus, when you know your total cost up front, and will only need that set amount, a home equity loan can be preferable and less costly. To give yourself added flexibility to meet recurring needs and expenses, a HELOC will give you ease of access to the credit you require, though you should aim to pay back the balance on your HELOC sooner rather than later.

The following chart compares key aspects of home equity loans and HELOCs:

*Interest payments are tax deductible for home equity loans and HELOCs, as long as the amount borrowed is used to finance improvements to the home.