Home Equity Loans vs HELOCs: Key Differences Explained

Two Ways to Borrow Against Your Home—and Why the Difference Matters

American homeowners collectively held roughly $17 trillion in home equity as of early 2024, according to Federal Reserve data. Two products let them tap that wealth: the home equity loan and the home equity line of credit, or HELOC. Both use your home as collateral. Both are second mortgages in the legal sense. But they function in almost opposite ways, and choosing the wrong one can cost thousands of dollars or leave a borrower dangerously exposed to variable rates.

How a Home Equity Loan Works

A home equity loan is a closed-end loan. You borrow a fixed amount on day one and receive it as a lump sum. The lender sets a fixed interest rate, you make equal monthly payments over the loan term (typically 5 to 30 years), and the balance decreases with every payment—exactly like a conventional mortgage.

Fixed rate. Fixed payment. No surprises. That predictability makes home equity loans popular for one-time large expenses such as a full kitchen renovation, a medical procedure, or consolidating high-interest credit card debt into a single payment at a lower rate.

Average rates for home equity loans in early 2024 hovered between 8.5% and 9.5%, depending on loan-to-value ratio and credit score. Lenders typically allow borrowing up to 80%–85% of the home's appraised value minus any outstanding first mortgage balance.

How a HELOC Works

A HELOC is open-end revolving credit—more like a credit card secured by your home than a traditional loan. The lender approves a maximum credit limit, and the borrower draws what they need, when they need it, during the draw period. Most HELOCs have a 10-year draw period followed by a 20-year repayment period.

During the draw period, borrowers often pay interest only on the amount drawn. During repayment, they pay principal and interest on the outstanding balance. Rates are almost always variable, typically tied to the prime rate. When the Federal Reserve raised rates by 525 basis points between March 2022 and July 2023, HELOC monthly payments surged for existing borrowers who had drawn large balances.

Side-by-Side Comparison

Tax Deductibility After the 2017 Tax Cuts and Jobs Act

Before 2018, interest on home equity debt was deductible up to $100,000 regardless of how the money was spent. The Tax Cuts and Jobs Act changed that. Now, interest on home equity loans or HELOCs is deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan. Using a HELOC to pay off credit cards or fund a vacation eliminates any deduction.

• Renovation projects (kitchen, roof, addition) — deductible up to the debt limit
• Debt consolidation — not deductible under current law
• Medical bills or tuition — not deductible
• Married filers can deduct interest on up to $750,000 of total mortgage debt (combined first and second mortgage)

The $750,000 cap replaced the previous $1 million cap. Loans originated before December 16, 2017 grandfathered under the old rules are still subject to the new use-of-funds test for deductibility purposes.

The Foreclosure Risk That Most Borrowers Underestimate

Both products put your home on the line. Miss enough payments and the lender can foreclose—regardless of how much equity you have built up. HELOC borrowers face a compounded risk: if rates rise sharply during the repayment period, the monthly payment can jump substantially from what was projected at origination.

A borrower who drew $80,000 on a HELOC at a 6% rate in 2021 saw that rate climb above 9% by late 2023 when the prime rate hit 8.5%. A $80,000 balance at 9% over 20 years carries a monthly payment roughly $200 higher than the same balance at 6%. Multiply that across a larger draw and across years, and the stress becomes acute.

Which One Fits Your Situation

Fees and Qualification Standards

Both products require an appraisal in most cases, a credit check, and income verification. Lenders generally want:

• Credit score of at least 620; scores above 720 unlock the lowest rates
• Debt-to-income ratio below 43%–50%
• At least 15%–20% equity in the home after accounting for the new loan
• Two years of stable income documentation

Some lenders offer no-closing-cost HELOCs, recovering costs through a slightly higher rate. Home equity loan closing costs range from 2% to 5% of the borrowed amount—on a $50,000 loan that means $1,000 to $2,500 due at closing. Always calculate the total cost of borrowing, not just the rate.

Choosing Between a Fixed Rate and a Variable Rate Environment

When interest rates are near historic lows, a fixed-rate home equity loan locks in that advantage for the full term. When rates are elevated and expected to fall—as many economists projected for 2024 and 2025—a variable-rate HELOC could become cheaper over time. The Federal Reserve's rate trajectory, your personal risk tolerance, and the certainty of your spending plan all factor into the decision.

Neither product is universally superior. The right choice depends entirely on how and when you need the money, and how much payment volatility you can absorb.

This article is for informational purposes only and does not constitute financial advice. Consult a qualified financial professional before borrowing against your home.