HELOC vs. Home Equity Loan: 15 Pros and Cons to Consider

Your equity in your home can serve as collateral if you want to borrow money. That makes home equity lines of credit (HELOCs) and home equity loans potential sources of cash that you can use for a variety of reasons.

At Addition Financial, we work closely with our members to help them achieve their financial goals. The topic of home equity lending is a common one, with many of our members asking us to explain the HELOC vs home equity loan pros and cons.

With that in mind, we reached out to a panel of financial experts to ask them about the pros and cons of HELOCs and HELs as they see them. Here are 15 considerations to help you decide which type of home equity lending best suits your needs.

Home Equity Loan Pros and Cons

We’ll start with home equity loan pros. Here’s what you should keep in mind:

1. Todd Christensen of MoneyFit told us, “Home Equity Loans, with their set monthly payment and pay off dates, make it easier to repay and get out of debt.” If you want to use your home equity to get out of debt, you may want the option that offers predictability in monthly payments and interest rates.
2. Cindy Sosa Sanchez of We Buy Houses Cash DMV told us that home equity loans provide “access to a large amount of money at once.” That’s because home equity loans offer a lump-sum payment when the loan is approved.
3. Michael Hammelburger of Expense Reduction Group told us, “Home equity loans have the advantage of having a fixed interest rate. This means that your monthly payments won't change throughout the life of the loan.” Fixed rates and payments make budgeting easy and may be preferable for some homeowners.
4. Mortgage Loan Officer Jane Hammond mentioned that discipline plays a key role in which type of home equity borrowing makes sense. She said, “If the homeowner determined in their financial goals that they need to set stricter guidelines for themselves until they are better at controlling their spending, the set amount of an equity loan can consolidate their credit card debt without giving them the opportunity to use their equity on things that don't have lasting value.”

Now, let’s review some of the potential downsides of a HEL as revealed by our experts:

1. Cindy also mentioned a potential downside of home equity loans. She said, “[Borrowers] cannot access draws for funds as needed.” Because HELs offer only one withdrawal option – a large one-time payment – if you need to borrow again you will need to apply for a new loan. The costs of doing that can add up.
2. Another HEL con from Cindy has to do with interest. She points out that “interest accrues across the entire outstanding balance” with a HEL, where with a HELOC, you pay interest only on what you borrow. Depending on what your borrowing needs are, you may prefer the lower interest rates of a HELOC.
3. Home equity loans can tap out your home’s equity and if you are upside down on your home, you won’t be able to borrow against your equity again until you’ve paid off the loan. You may also not be able to sell your house.

A home equity loan can be beneficial provided you are prepared to deal with the monthly payments and having all of your equity tied up until the loan is repaid.

HELOC Pros and Cons

There are some significant advantages associated with getting a HELOC. Here are the things our contributors told us:

1. Jonathan Sanchez of ParentPortfolio told us, “The closing costs associated with acquiring a HELOC [are] much lower compared to acquiring a home equity loan. Although the home equity loan has a fixed rate, a person is expected to pay interest for the set period. For a HELOC, interest is only charged for the current balance borrowed from month to month.” Depending on what happens with interest rates, you may end up paying significantly less interest for a HELOC than you would for a HEL.
2. Paul Weaver of The Income Finder mentioned one significant benefit of HELOCs. He told us, “ [The] revolving nature [of a HELOC] allows you to borrow and repay as needed [and] saves interest expense.” You’ll have far more borrowing flexibility with a HELOC because you can repay and borrow again over the withdrawal period. For Addition Financial HELOCs, the withdrawal period is 20 years.
3. Paul also told us, “[HELOCs are] great for shorter term capital needs – best to be paid back in less than 5 years.” His point about quick repayment is a good one. If you get a HELOC at a time when rates are low, you can get the capital you need and save on interest by paying it back quickly.
4. Cindy brought up another aspect of interest that can make HELOCs a good option. She pointed out that with some HELOCs, you can make interest-only monthly payments.That can be a benefit because interest payments are low compared to HELOC repayments and can help you to defray some of the costs when you do start to repay.

Now, let’s look at some of the potential downsides of a HELOC:

1. Todd has this to say about HELOCs. “Home Equity Lines of Credit, like credit cards, lead the majority of borrowers to over spend, using their home equity to purchase or pay for things they did not plan for when originally taking out the loan. Their flexibility is a positive thing, but it does not outweigh the high likelihood of using it for consumer spending in most households.” The takeaway here is that it’s essential to spend responsibly with a HELOC to make sure you don’t overdo it.
2. Rob Drury of Christian Financial Advisors tells us that it’s essential for borrowers to understand what the HELOC’s variable interest rate means. He says, “While most equity loans are fixed rate simple interest, most HELOCs are offered at revolving variable rates, similar to credit card accounts. Given an equivalent APR, the line accumulates interest far more quickly [than borrowers might expect.]” The variable rate interest can be beneficial when interest rates are low but it’s important to be mindful that they can change and prepare to make payments at the rate required if your HELOC tops out its interest rate.
3. Paul mentioned a potential con in addition to the two pros we’ve already mentioned. He points out that some HELOCs charge a fee if you close the line early – typical within two or three years. You can avoid those charges by borrowing even a small amount to keep the line active.
4. We’d be remiss if we didn’t mention another potential downside of a HELOC, which is that making interest-only payments has the potential of making borrowers forget that the payments will be significantly higher once they get to the repayment period. It’s important to play for the increase, so you don’t get caught by surprise.

HELOCs offer potential savings when interest rates are low, but it’s essential to be mindful of your spending and not overdo it.

Should You Borrow Against Your Home Equity?

One of the downsides mentioned by many of our financial experts applies to both home equity loans and home equity lines of credit. It has to do with the risks of not having any equity.

If you take out a home equity loan that is equal to your equity – or you borrow against a HELOC up to the full credit limit – you won’t have any equity in your home until you pay down the balance. That means you won’t be able to borrow against your equity again. It also means that you may not be able to sell your home if its value decreases.

You probably know that the housing market can be volatile. It’s worth thinking about what you would do if you had no equity and wanted to sell your home.

There is one spending option that can potentially eliminate the risk of losing equity. If you put some or all of the money you borrow into renovating your home and making improvements that increase its value, you can gain equity over the course of the loan.

If you do decide to make home improvements with the money you borrow, make sure to research them first. Some home improvements offer more than a dollar-for-dollar increase in equity while others offer less. It may be helpful to consult with a real estate agent to learn which features are most likely to build your equity and increase the value of your home.

Home equity loans and home equity lines of credit each have their pros and cons. You’ll need to weigh your options to determine which type of equity lending makes sense for you and your financial needs.

Are you interested in applying for a home equity line of credit? Addition Financial offers affordable rates and more. Apply online now!