• HELOCs and home equity loans allow homeowners to tap into their home equity to access funds.
  • HELOCs are revolving lines of credit, allowing as-needed borrowing, while home equity loans are lump-sum loans.
  • Depending on your financial goals, either option may be a good fit for you. It’s easy to apply for a HELOC or home equity loan online.

In this article, you will get answers to your most pressing HELOC vs. home equity loan questions, including:

  • What is home equity, and how do I access some of the cash value?
  • Why would someone borrow against their equity, and is it a good idea?
  • How are HELOCs and home equity loans similar?
  • What is the difference between a home equity loan and a HELOC?
  • How can I decide between a HELOC vs. a home equity loan?

What Is Home Equity and How Is It Used?

Home equity is the difference between the current market value of your home and how much you owe in mortgage debt on the home. This is the share of the home’s value that you own, as opposed to the share of the value financed by the lender.

For example, if your home is currently worth $400,000 and your principal mortgage balance is $100,000, you have $300,000 in home equity. 

As a homeowner, you can access a portion of this equity by borrowing against it through either a HELOC or a home equity loan.

Common Reasons To Borrow Against Your Equity

Before we discuss the similarities and differences between a home equity loan and a line of credit, here is a list of reasons why homeowners may choose to borrow against their home equity:

  • To cover an unexpected expense (like car repairs or emergency medical bills, for example).
  • To finance home improvements or renovations.
  • To free up capital for the down payment on an investment property.
  • To consolidate existing debts.
  • To pay for college.
  • To start a business.
  • To buy a second home or vacation property.

Whatever your reason, a HELOC or home equity loan can help convert some of your home equity into funds. 

Two Ways To Utilize Your Equity: The HELOC and the Home Equity Loan

HELOCs and home equity loans both allow you to borrow against your home equity. They are similar in several ways, but they work differently in practice. 

What HELOCs and Home Equity Loans Have in Common 

HELOCs and home equity loans share the following characteristics. 

Both Are Secured By Using Your Home as Collateral

It’s important to understand that your house is used as collateral when borrowing against home equity. This means that failure to repay the loan could potentially lead to a foreclosure by the lender.[1]

So, before deciding to borrow against your home equity, you should carefully weigh the need for the funds and your ability to repay the loan.

Both Require an Appraisal of Your Home

Since your home secures the loan, lenders need to confirm the value of your home before issuing a HELOC or home equity loan. This is done through a formal valuation, most commonly called an appraisal, which is completed by a licensed home appraiser.

The appraisal process involves researching recent sales of comparable properties to estimate the current value of a home. In some cases, an appraiser may need a quick tour of the subject property to assess the current condition or confirm upgrades that can enhance the property’s value. However, with so much information available online, such as the square footage, year built, and permits granted,  valuations can often be completed virtually without an in-person evaluation.

The appraised value of the home may influence the loan amount. This is because lenders have requirements relating to how much equity the homeowner must retain in the property, and the appraised value directly impacts home equity calculations.

Both Come with Closing Costs 

New loans and lines of credit often come with closing costs. These costs include various fees and expenses, including:

  • Application fees, 
  • Appraisal expenses,
  • Loan origination fees,
  • Document preparation costs,
  • Title fees,
  • Attorney fees, and
  • Recording costs. 

Closing costs can vary widely from one loan to the next due to a number of factors, including location, loan type, and loan amount. 

It’s important to note that you may not need to pay these closing costs out of pocket. It may be possible to roll these costs into the loan and repay them over time as part of your regular HELOC or home equity loan payments. Some lenders will only require loan fees to be paid if you pay off and close your loan or line within a certain period of time. 

What Is the Difference Between a HELOC and a Home Equity Loan?

The primary difference between a home equity loan and a home equity line of credit is how loan proceeds are accessed. With a home equity loan, you receive the amount borrowed (minus any fees and costs) in a single lump sum with a predetermined repayment schedule. 

But with a HELOC, you are granted a line of credit that you can access as needed during the initial draw period (which may last around 10 years). Much the same as using a credit card, qualified borrowers are approved for a maximum credit limit and can draw up to the predetermined limit. Borrowers repay the amount drawn on a monthly basis, as outlined by the terms of their HELOC contract. After the draw period comes a repayment period, during which the principal and interest must be fully repaid (this may last around 30 years).  Monthly payments will vary based on the outstanding principal balance and the applicable Annual Percentage Rate (APR).[2]

Another important difference between a home equity loan vs. a line of credit is the interest rate. Home equity loans typically offer flat (fixed) interest rates, meaning the rate is locked in for the term of the loan. HELOCs, on the other hand, typically offer variable interest rates that fluctuate with changing market conditions. However, PNC Bank offers Fixed-Rate Lock Options on HELOCs for those who prefer the flexibility of a HELOC with the stability of a set interest rate.

Pros and Cons of HELOCs vs. Home Equity Loans

What Are the Advantages and Disadvantages of a HELOC?

There are several pros and cons of using your home equity for a line of credit.[3]

Advantages of a HELOC:

  • You can borrow small increments as needed. This flexible system can help you borrow only what you need and keep monthly payments manageable.
  • HELOCs typically come with lower interest rates and higher loan limits than unsecured products like credit cards and personal loans.
  • You may be able to get an interest-only (IO) HELOC. With an IO HELOC, only interest is due during the “draw period” (the designated time that you can access your equity).*
  • You may not need to start repaying the balance until the draw period closes and a repayment period begins. This can mean low monthly payments during the draw period, but it also means higher payments during the repayment period.
  • Making on-time payments can boost your credit score over time.

Potential downsides of a HELOC:

  • HELOCs typically have variable interest rates. If market rates rise, your monthly payment can increase. 
  • Interest paid may be tax-deductible in some cases. Consult a tax advisor for personalized guidance.
  • Failure to repay a HELOC can potentially result in foreclosure of the home.
  • In addition to the closing costs for establishing the line of credit, there may be ongoing fees to maintain the credit line

What Are the Advantages and Disadvantages of a Home Equity Loan?

Here are the pros and cons of home equity loans.[4]

Pros of a home equity loan:

  • Home equity loans typically come with a fixed interest rate, which allows for a predictable monthly payment.
  • You get a lump sum that can be spent or invested as you see fit.
  • There are no ongoing account maintenance charges or annual fees.
  • You won’t have an open credit line to encourage unnecessary spending.

Potential disadvantages of a home equity loan:

  • Borrowing too much could lead to unnecessary interest expenses, and borrowing too little could require applying for another loan.
  • Failure to repay the loan can potentially result in foreclosure of the home.
  • There may be fees for originating the loan, plus other closing costs. Costs for a home equity loan may be higher than the costs of opening a HELOC.

How To Decide Which Is Best for You

HELOC Pros and Cons
Pros Cons
Borrow small increments as needed. Often have variable interest rates.
Lower interest rates and higher loan limits than credit cards. Interest paid may be tax deductible in some cases. Consult a tax advisor for personalized guidance.
On-time payments can boost your credit score over time. Failure to repay can potentially lead to home foreclosure.

 

Home Equity Loan Pros and Cons
Pros Cons
Fixed interest rates for predictable payments. Could potentially borrow too much or too little.
Lump-sum amount May cost more than opening a HELOC
No ongoing account maintenance charges or annual fees. Failure to repay can potentially lead to home foreclosure.

HELOCs may be a good option for homeowners who:[5]

  • Are unsure how much money they will need to borrow.
  • Don’t need funds now, but want an open line of credit for emergencies.
  • Are willing and able to budget for variable interest rates and changing balances.

Home equity loans may be a good option for homeowners who:[5]

  • Know exactly how much money they need.
  • Prefer the stability of fixed rates and a scheduled repayment plan.

Risks of Home Equity Loans and HELOCs (and How to Protect Yourself)

It is important to fully understand the potential risks associated with borrowing against your home equity as well as your consumer rights. 

The primary risks of borrowing against home equity are:

  • Failure to repay the loan as scheduled could potentially result in foreclosure, which is when the lender takes possession of the property.[1]
  • If you have a variable interest rate, any increase in rates could increase your monthly payment amount, potentially making the payments more difficult to cover.[1]

Because of these two risks, it’s critical to make sure you can comfortably afford to repay the debt (even if interest rates increase to the maximum outlined by the terms of your agreement) before moving forward with the loan.

Protection During the Application Process and Beyond

Consumer protections are in place to help you mitigate the risks. 

The Three-Day Right to Cancel

In most cases, borrowers have the option to cancel a HELOC or home equity loan within three business days of signing the loan agreement.[1] This “cooling off period” gives you a chance to review your decision and make sure you’re comfortable proceeding. 

If you decide not to move forward and collect your funds, you must notify your lender in writing of your intention to cancel by midnight of the third business day after signing the home equity loan closing documents or opening the HELOC plan.[1]

The three-day rescission period may be waived in cases of a bona fide personal financial emergency.

Consumer Rights After Accepting the Loan or Line of Credit

Once the funds are released, the lender may not close your account, change the terms of the agreement, or demand that you speed up the repayment schedule as long as you repay the debt as planned.[1]

However, HELOC lenders may freeze or reduce the line of credit in certain cases, such as:[1]

  • If interest rates exceed the maximum stated in your agreement (depending on your contract).
  • If the value of the home declines significantly from the appraised value.
  • If there is a material change in your finances that reasonably leads the lender to believe that you may be unable to make payments as scheduled.

If your HELOC limit is decreased or funds are frozen, you may ask your lender to restore the credit line or apply for another line of credit.

How To Apply for a HELOC or Home Equity Loan

Once you decide which is the better fit for you, a HELOC or a home equity loan, you can begin the application process. Here are the five steps to applying for a HELOC or home equity loan.

Step 1. Review Lender Requirements 

Your lender wants to make sure that you are financially able to take on additional debt. Lenders also check to see if you have enough equity in the home to borrow against. Most lenders require that homeowners retain at least 15-20% equity in their homes.[6]

Step 2. Gather Your Documents

To apply for a loan against your home equity, you may need the following:[7]

  • Government-issued proof of identification (a driver’s license, state ID, or passport).
  • Proof of income (pay stubs, W2s, and/or income tax returns, as applicable, plus proof of any retirement or supplemental income).
  • Financial information about your property expenses (mortgage statements, insurance statements, and property tax bills, as applicable).

Step 3. Complete the Application

The loan application and supporting documentation will provide the lender with the information needed to determine if a loan can be offered and in what amount.

Step 4. The Lender Will Order a Home Appraisal

The appraisal determines the property’s current value, influencing the potential loan amount. In many cases, a full on-site appraisal is unnecessary. Instead, the appraiser can gather information about the property online, along with details of comparable homes that have recently sold.  

Step 5. Arrange the Closing and Access Your Funds

The closing costs for the loan can either be paid up front or rolled into the cost of the loan. When paid upfront, you avoid interest charges on the amount of the closing costs. However, many borrowers are willing to pay the interest to avoid paying the fees up front out of pocket. 

Use Your Home Equity To Access Funds When You Need Them

Building equity is one of the greatest perks of homeownership. Are you interested in exploring a home equity loan or HELOC? Connect with a PNC mortgage loan officer (MLO) today by calling 1-855-744-2268. Your MLO will walk you through each option and help you choose the one that best fits your financial needs.