These 3 Questions Can Help You Decide Between a Home Equity Loan and a HELOC

Many people have a lot of equity in their homes, either because they've paid down their mortgage loan balances or because property values have risen dramatically over the past year or so.

Some property owners may want to tap into the equity in their home and use that money to finance other things, such as paying down higher-interest debts or funding home improvements. And if you are one of those owners, you have two choices for how to access your equity: a home equity loan or a home equity line of credit.

Answering the following questions can help you decide which option is best for you.

1. Do you know exactly how much you need to borrow?

In some cases, you may want to borrow a specific amount of money for a defined purpose. In other situations, you may not be exactly sure how much money you're ultimately going to need from your lender.

If you have a designated amount you would prefer to borrow, consider going with a home equity loan. This loan gives you a lump sum, and you can't borrow any more than that amount. You receive the borrowed funds all at once, begin making payments once you have the loan, and you know your exact repayment obligations up front.

If you know you need to borrow but aren't sure exactly how much, then you're better off with a home equity line of credit, or HELOC. That's because a HELOC allows you to borrow up to a certain amount of money. You can borrow as little or as much as you want at any time, up to the maximum line of credit the lender offers.

2. Will you potentially need to borrow multiple times?

When you take out a home equity loan, you get all of the money you're borrowing at once. This works out well if you want to take out a loan for a specific purpose. But if you'd prefer more flexibility, a HELOC could be a better fit. With a HELOC, you can borrow up to the maximum limit, and then, as you pay down the amount you've borrowed, the credit becomes available to you again. The HELOC works kind of like a credit card -- both are revolving lines of credit. But it typically comes with a much lower rate than a credit card does.

3. Would you prefer a fixed or variable rate loan?

With a home equity loan, you usually choose a fixed or variable rate loan. If you'd prefer a fixed rate loan, this makes a home equity loan a better choice than a HELOC. A fixed rate loan provides more predictability, since your costs of borrowing won't change.

HELOCs, on the other hand, are usually variable rate loans, so you risk rates rising. You may be willing to take that risk to get the flexibility HELOCs provide -- but carefully consider the answers to all three of these questions so you can decide which loan option is best for your situation.

A historic opportunity to potentially save thousands on your mortgage

Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.

Our expert recommends this company to find a low rate - and in fact he used them himself to refi (twice!).

Read our free review

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Latest Markets Videos

The Motley Fool

Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

Learn More