Unlocking Home Equity: HELOCs vs. Home Equity Loans – Which is Right for You?

For the past few years, borrowing against your home equity has been one of the better ways to get money. When inflation rose and interest rates went up, borrowing options like credit cards and personal loans became very expensive. Home equity interest rates also increased, but they still stayed lower than most other options because your home acts as collateral.

Now, the Federal Reserve has cut interest rates again, following a previous cut earlier this year, and more cuts could be on the way. This change makes it a good time to understand how home equity loans and home equity lines of credit (HELOCs) might be affected, so you can make a smart choice about which one is better for you.

Not sure which step to take in your home equity borrowing process? Here’s what you need to know about both HELOCs and home equity loans right now.

HELOCs

• A Higher Rate: HELOC interest rates are generally higher compared to home equity loans right now, but they are still much lower than credit cards or personal loans. As of November 1, HELOC rates average 8.68%, while home equity loans average 8.35%. While this difference may seem small, it can add up over a 10- or 15-year repayment period, leading to significant savings if you choose the lower rate.
• Variable Interest Rates: HELOCs have variable rates that change every month. Sometimes the rate changes are small, but if rates rise quickly, it can be hard to budget for the extra cost. On the other hand, if rates go down, it could save you money. However, the uncertainty of the rate can make it tricky to plan ahead.
• Revolving Line of Credit: A HELOC works like a credit card. You have a line of credit, but you only pay interest on the amount you actually use. This makes it a flexible choice if you are not sure how much money you will need. Plus, if you use a HELOC for home repairs, you might be able to deduct the interest when you file your taxes.
  
  Example Story: Imagine Sarah needs money to renovate her kitchen, but she’s unsure how much it will cost. She decides to get a HELOC because it works like a credit card—she only pays interest on the money she ends up using. This flexibility is great for her, especially since she can do her renovations in stages and borrow only what she needs at each step.  

Home Equity Loans

• A Lower Rate: Home equity loans have slightly lower rates than HELOCs right now, at an average of 8.35%. While the difference compared to HELOCs may not seem like much, the savings add up over time. Since the rate is fixed, you don’t have to worry about market changes, making it easier to budget.
• Fixed Rate Might Need Refinancing: The interest rate on a home equity loan is fixed, which is usually good if rates go up, but less ideal if rates go down. If rates drop after you get your loan, you would need to refinance to get the new lower rate, which can cost 1% to 5% of the loan amount in closing costs. Depending on how much you borrowed, this can be a significant amount of money. If refinancing isn’t something you can afford, a HELOC might be a better choice.
• Access to a Big Sum: The average home equity amount is about $330,000 right now, and many lenders allow you to borrow up to 80% of that amount. This means you could have access to a large amount of money to use as you need. Just keep in mind that the amount available to you could change if the housing market shifts.
  
  Example Story: John wants to consolidate his high-interest credit card debt. He decides to get a home equity loan because it offers a lower interest rate and a fixed rate, which means his monthly payments will always be the same. This way, he knows exactly how much he will need to pay each month, and he can budget accordingly without worrying about changing rates.

The Bottom Line

Both HELOCs and home equity loans can be great tools for homeowners, but they are not always simple to use. You need to carefully choose the right product and rate, while making sure you are not taking on more debt than you can handle. By understanding how each of these products works and their pros and cons, you can make a more informed decision about whether a HELOC or a home equity loan is the right way for you to get the money you need right now.

Key Financial Terms

• Collateral: Property or assets that a borrower offers to a lender to secure a loan. If the borrower fails to repay, the lender can take the collateral. Example: Your home is used as collateral when you take out a HELOC or home equity loan.
• Interest Rate: The percentage of a loan amount that a lender charges as interest to the borrower, typically expressed as an annual percentage rate (APR). Example: If your HELOC interest rate is 8.68%, you’ll pay that percentage in interest on the amount of credit you use.
• Variable Rate: An interest rate that changes over time based on market conditions. Example: A HELOC has a variable rate, meaning the interest rate can go up or down depending on changes in the market.
• Fixed Rate: An interest rate that does not change for the entire loan term. Example: A home equity loan has a fixed rate, so your monthly payments will always be the same.
• Line of Credit: An amount of credit extended to a borrower that they can draw from as needed, up to a maximum limit. Example: A HELOC gives you a line of credit that you can use for things like home repairs.
• Refinancing: The process of replacing an existing loan with a new one, usually to get a lower interest rate. Example: If interest rates drop after you have a home equity loan, you might refinance to get the lower rate.