Are you sitting on a goldmine without even realizing it? If you’ve owned your home for a while, chances are you’ve built up equity that could be tapped for various financial needs. Whether you’re dreaming of a kitchen renovation, need to consolidate high-interest debt, or want to fund a child’s education, your home’s equity can be a powerful financial tool.
Two popular ways to access this equity are home equity loans and home equity lines of credit (HELOCs). While both options let you borrow against your home’s value, they work quite differently. Understanding these differences is crucial for making the right choice for your financial situation.
In this guide, we’ll walk through everything you need to know about home equity loans and HELOCs in clear, straightforward terms. By the end, you’ll have the knowledge to confidently choose the option that best fits your needs.
What Is Home Equity?
Before diving into the specifics of each borrowing option, let’s make sure we’re on the same page about what home equity actually is.
Home equity is the difference between your home’s current market value and the amount you still owe on your mortgage. For example, if your home is worth $400,000 and you owe $250,000 on your mortgage, you have $150,000 in equity.
Your equity grows in two ways:
- As you make mortgage payments that reduce your loan balance
- As your home increases in value over time
This equity represents real wealth that you can potentially tap into when needed.
Home Equity Loan: The “Second Mortgage”
A home equity loan is often called a “second mortgage” because it’s a separate loan that uses your home as collateral, just like your primary mortgage.
How Home Equity Loans Work
With a home equity loan, you borrow a specific amount of money in one lump sum and repay it over a set period, typically 5 to 30 years. The loan comes with a fixed interest rate, which means your monthly payments remain the same throughout the loan term.
Most lenders allow you to borrow up to 80-85% of your home’s value, minus what you still owe on your primary mortgage. Using our previous example of a $400,000 home with $250,000 still owed on the mortgage:
- 85% of home value = $340,000
- Minus mortgage balance = $250,000
- Maximum potential equity loan = $90,000
Advantages of Home Equity Loans
1. Predictable payments: With a fixed interest rate, your monthly payments never change, making budgeting easier.
2. Lump sum availability: You receive all the money at once, which is ideal for large, one-time expenses like major home renovations or debt consolidation.
3. Potentially lower interest rates: As of May 2025, the average home equity loan rate is around 8.37%, according to Bankrate’s national survey of lenders. While this is higher than rates seen in previous years, it’s still typically lower than credit card rates or personal loans.
4. Possible tax benefits: In some cases, the interest paid on home equity loans may be tax-deductible if the funds are used for home improvements. (Always consult with a tax professional about your specific situation.)
Disadvantages of Home Equity Loans
1. Risk to your home: Since your home serves as collateral, failing to repay the loan could result in foreclosure.
2. Closing costs: Like your primary mortgage, home equity loans often come with closing costs, including application fees, appraisal fees, and other charges that typically range from 2% to 5% of the loan amount.
3. Borrowing more than needed: Since you receive all the money upfront, you might end up borrowing (and paying interest on) more than you actually need.
Home Equity Line of Credit (HELOC): Flexible Borrowing Power
A HELOC works more like a credit card than a traditional loan. Instead of receiving a lump sum, you get access to a line of credit that you can draw from as needed during a set period.
How HELOCs Work
A HELOC has two distinct periods:
1. Draw period: Typically lasting 5 to 10 years, during which you can borrow against your credit line as needed. During this time, you might only be required to make interest payments on the amount you’ve borrowed.
2. Repayment period: Usually 10 to 20 years, during which you can no longer borrow and must repay both principal and interest.
Like home equity loans, most lenders will allow you to access up to 80-85% of your home’s value, minus your mortgage balance.
Advantages of HELOCs
1. Flexibility: You only borrow what you need, when you need it, which is ideal for ongoing projects or expenses that occur over time.
2. Interest only on what you use: You only pay interest on the amount you’ve actually borrowed, not the entire credit line.
3. Potential interest-only payments: During the draw period, some HELOCs allow you to make interest-only payments, keeping your monthly payments lower.
4. Current lower rates: As of May 2025, HELOC rates have been trending downward, with the average rate around 8.03%, according to Bankrate. This represents a two-year low, making HELOCs increasingly attractive for borrowers.
Disadvantages of HELOCs
1. Variable interest rates: Most HELOCs have variable rates tied to the prime rate, which means your payments can fluctuate as interest rates change. While some lenders offer fixed-rate options for portions of your balance, the basic HELOC structure involves variable rates.
2. Payment shock potential: When the draw period ends and the repayment period begins, your monthly payments can increase significantly as you start paying both principal and interest.
3. Temptation to overspend: The easy access to funds can lead some borrowers to tap their equity for non-essential expenses, potentially putting their homes at risk.
4. Potential for frozen credit lines: In economic downturns, lenders may freeze or reduce HELOC credit lines if home values decline.
Current Trends in Home Equity Borrowing (2025)
The home equity lending landscape has evolved significantly in recent years. Here are some current trends worth noting:
1. Declining interest rates: After reaching highs in early 2024, both HELOC and home equity loan rates have been trending downward in 2025. According to financial experts at Bankrate, HELOC rates are expected to average around 7.25% by the end of 2025, their lowest level in three years.
2. Increasing home equity: Despite economic uncertainties, total homeowner equity reached $34.7 trillion as of the fourth quarter of 2024, just slightly below the record high of $35.5 trillion set in Q2 2024.
3. Growing HELOC balances: Balances on HELOCs rose by $9 billion in the fourth quarter of 2024, marking the 11th straight quarter of growth as homeowners increasingly tap their equity.
4. Competitive introductory offers: Many lenders are offering attractive introductory rates on HELOCs to entice borrowers, even as the Federal Reserve has paused rate cuts in early 2025.
Which Option Is Right for You?
Choosing between a home equity loan and a HELOC depends on your specific financial needs and preferences. Here are some scenarios to consider:
Consider a Home Equity Loan If:
- You know exactly how much money you need
- You prefer predictable monthly payments
- You’re funding a one-time, large expense (like a major home renovation)
- You want protection from potential interest rate increases
- You’re consolidating high-interest debt and want a fixed repayment plan
Consider a HELOC If:
- You’re unsure of the exact amount you’ll need
- You have ongoing expenses or projects that will require funds over time
- You want flexibility in how much you borrow
- You’re comfortable with potentially variable monthly payments
- You want to pay interest only on what you actually use
- You might benefit from making interest-only payments during the draw period
Real-World Example: Home Renovation
Let’s look at how each option might work for a common use of home equity: a home renovation project.
Scenario: You’re planning a kitchen remodel estimated to cost $50,000.
With a Home Equity Loan:
- You borrow $50,000 at a fixed rate of 8.37%
- On a 15-year term, your monthly payment would be approximately $488
- This payment remains the same for the entire loan term
- You receive all $50,000 upfront to pay contractors
With a HELOC:
- You open a $50,000 line of credit with an initial variable rate of 8.03%
- You draw funds as needed throughout the project
- If you only need $45,000 in the end, you only pay interest on that amount
- During the draw period, you might make interest-only payments
- After the draw period ends, your payments increase to cover both principal and interest
Is a Cash-Out Refinance an Alternative?
While considering home equity options, you might wonder about cash-out refinancing. Unlike home equity loans or HELOCs, a cash-out refinance replaces your existing mortgage with a new, larger one, and you receive the difference in cash.
This option might make sense if:
- Current mortgage rates are significantly lower than your existing mortgage rate
- You want to maintain just one loan instead of adding a second mortgage
- You’re planning to stay in your home long enough to recoup the closing costs
However, cash-out refinancing typically involves higher closing costs and resets your loan term, potentially increasing the total interest paid over the life of the loan.
Protecting Your Home: Important Considerations
Before tapping your home’s equity, consider these important factors:
1. Affordability: Can you comfortably manage the additional monthly payments, even if your financial situation changes?
2. Purpose: Are you using the funds for something that provides long-term value or financial benefit?
3. Home value fluctuations: Remember that home values can decrease, potentially leaving you owing more than your home is worth if you borrow too much.
4. Shopping around: Interest rates, terms, and fees can vary significantly between lenders, so it’s worth getting multiple quotes.
5. Reading the fine print: Understand all terms and conditions, especially for HELOCs with introductory rates or potential rate caps.
Application Process and Requirements
Whether you choose a home equity loan or HELOC, the application process is similar to getting a mortgage. You’ll typically need:
- A credit score of 620 or higher (though 700+ will get you better rates)
- A debt-to-income ratio below 43% (including the new loan payment)
- Sufficient equity in your home (typically at least 15-20%)
- Proof of income and employment
- A home appraisal to determine current value
The process usually takes 2-6 weeks from application to funding.
Final Thoughts: Making Your Decision
Choosing between a home equity loan and a HELOC requires careful consideration of your financial goals, cash flow needs, and risk tolerance. Home equity loans offer predictability and structure with fixed rates and lump sum payments, making them ideal for specific one-time expenses. On the other hand, HELOCs provide flexibility in accessing funds as needed and may offer lower initial payments during the draw period.
With home equity rates trending downward in 2025, both options are becoming increasingly attractive for homeowners looking to leverage their property’s value. HELOC rates in particular have reached two-year lows, approaching 8%, while home equity loan rates have stabilized around 8.37%.
Before making a decision, it’s wise to:
- Clearly define your funding needs and timeline
- Calculate how much equity you can reasonably access
- Compare offers from multiple lenders
- Consider consulting with a financial advisor, especially for large borrowing amounts
- Have a clear repayment plan in place
Remember that your home is likely your most valuable asset. While using its equity can be a smart financial move, doing so responsibly is essential to protect both your home and your financial future.
By understanding the differences between home equity loans and HELOCs and carefully assessing your own situation, you can make an informed choice that helps you achieve your financial goals while maintaining your long-term financial health.
