Understanding a HELOC vs. home equity loan for debt consolidation

Your home is more than a roof over your head. Under the right circumstances, the home you own could be a tool that helps you improve your financial situation. Home equity loans and HELOCs both let you borrow against the equity you’ve built in your home. Both types of loan could help you consolidate debts and put you closer to your financial goals. But there are differences to know before you choose one over the other. 

We’ll break down what you need to know about HELOCs vs. home equity loans for debt consolidation. 

A refresher on debt consolidation

Debt consolidation means using one new loan to pay off more than one debt. You might do this if you can lower the cost of your debt, free up money in your monthly budget, streamline your finances, or enjoy any combination of those benefits. When you consolidate multiple debts, you’re left with one payment instead of many. 

One way people consolidate debts is by borrowing against their home equity (equity is the difference between your home’s value and the amount you owe on your mortgage, if you have one). You might qualify to borrow against your equity if you have enough of it and you meet the lender’s other requirements.

How are home equity loans and HELOCs alike?

Flexibility

You can use either loan for almost any purpose.

Yes, it means you can use the money to consolidate your debt. Or handle much-needed home repairs or make a major purchase (like replacing an appliance). In other words, if you borrow more than you need to consolidate your debts, you could use the additional funds to reach another financial goal. The cash is at your beck and call—as long as it falls within the terms of your loan. A lender will most likely ask you why you want to take out a loan before approving your application. Debt consolidation is a great use of the money.

Secured by your home

HELOCs and home equity loans are both secured loans. They are mortgages. You pledge your home as a guarantee that you’ll repay the loan. If you don’t, you could lose your home. If you already have a mortgage, your HELOC or home equity loan would be a second mortgage. 

Larger loan amounts

Both home equity loans and HELOC lenders allow you to borrow against your home up to a certain percentage of your home’s value. This limit is called loan-to-value, or LTV. LTV includes what you owe on your current mortgage. Depending on how much equity you have, you might be able to borrow more than you could with a personal loan or by using a credit card.

For instance, if the lender limits home equity borrowing to 80% LTV, that means your home equity loan (or HELOC limit) plus your mortgage balance can’t be greater than 80% of your home’s market value at the time you get the loan. 

Fees and closing costs

Home equity loans and HELOCs are mortgages and may come with fees. These fees are similar to what you might have paid when you took out your mortgage and can range from 1% to 5% of the total loan amount. Your credit score and the loan amount can both affect the fees you pay. The tradeoff for lower fees is often a higher interest rate, so when you shop for a loan, keep in mind that fees don’t reflect the total cost of the loan. 

How are home equity loans and HELOCs different?

Lump sum vs line of credit

With a home equity loan, you’ll get a lump sum payment (all of the loan funds at once) when your application has been approved. The lender will start charging interest as soon as the money has been disbursed (deposited into your account or sent directly to your creditors for debt consolidation). Then, you make payments until the repayment term is over and all of the loan has been paid off. 

If you’re taking out a HELOC, you’ll be approved for a certain credit limit. There may be a minimum amount that you have to borrow when you’re first approved. Then, for the first few years, you can borrow, repay, and borrow more, up to your limit, as often as you like. This is called the draw period. The way it works is similar to a credit card, where you have a credit limit and can keep spending as long as you pay back what you borrow. Some lenders allow you to make interest-only payments during the draw period. If you do this, your debt won’t go down and you won’t free up the ability to borrow more. 

When the draw period ends, you’ll enter the repayment period. At this point, you can’t borrow more. You’ll pay off what you owe in equal monthly installments for the loan term you chose when you got the HELOC.  

After the draw period, if you only paid interest during the draw period, you could be in for sticker shock since your monthly payment will now include the principal (the amount you borrowed) as well as interest payments. 

Fees

Some HELOCs charge different fees such as maintenance or account inactivity fees, which home equity loans don’t have.

Interest rates

Home equity loans usually have a fixed interest rate that doesn’t change over time. HELOCs typically have a variable interest rate, which can make the cost of borrowing (and your payment amount) unpredictable. Some HELOCs convert to a fixed rate when you enter repayment. The best kind of HELOC is a fixed-rate HELOC because you get the flexibility of the draw period along with the predictability of the fixed interest rate. Achieve’s HELOC has a fixed interest rate.

Which one is better for me?

Either loan option is a fine choice, but the right one for you depends on why you want the loan in the first place. 

A home equity loan could be a good choice if you know exactly how much you need, and you need it all at once. Meaning, you already have a plan for how you’ll use the money. The more predictable payments on a home equity loan could also help you better manage your monthly budget since you know how much you owe each month. This amount stays the same.

A HELOC could be a good fit if you're not sure how much you need, or you don't need such a large amount right now. You can borrow just what you need during the draw periodIf you get a variable interest rate, your monthly payments could fluctuate. So look for a fixed-rate HELOC.