How a Home Equity Loan Works
A home equity loan is a second mortgage secured by your home. You receive a single lump sum at closing and repay it in equal installments over a fixed term, usually at a fixed interest rate. Because the house that secures your first mortgage also secures the second loan, lenders can generally offer a lower rate than they would on unsecured credit.
Payments are predictable, which makes budgeting straightforward. The loan also cannot be redrawn once the money is spent. Interest, however, begins accruing on the entire balance immediately, even if you do not need all of it at once.
Lenders typically cap total borrowing at a percentage of your home's appraised value minus the balance of your first mortgage. The CFPB mortgage tools and guides explain how home-secured credit works and what paperwork you should expect.
How a HELOC Works
A home equity line of credit, or HELOC, is a revolving line secured by your home. Rather than one lump sum, you receive a credit limit you can draw against, repay, and draw against again during the draw period, similar to a credit card but secured by real estate.
HELOCs generally have two phases. During the draw period you may borrow as needed and often make interest-only payments. When the draw period ends, repayment begins: you can no longer draw, and you must pay down principal plus interest over the remaining term. A payment that felt comfortable during the draw period can rise afterward, so plan for the repayment phase before you open the line.
Many HELOCs carry variable interest rates tied to an index, which means the rate and your payment can move up or down over time. Fixed-rate options and rate caps may be available, and the lender must give you the terms in writing before you sign. The CFPB homebuying and homeownership resources outline the disclosures involved.
Home Equity Loan vs HELOC at a Glance
The table below summarizes the structural differences. It describes how each product is designed in general terms, not what any specific lender offers.
| Feature | Home equity loan | HELOC |
|---|---|---|
| How funds arrive | One lump sum at closing | Revolving line you draw from |
| Interest rate | Usually fixed | Often variable; fixed options may exist |
| Monthly payment | Equal installments | Often interest-only during the draw period, then principal plus interest |
| Access after closing | No further draws | Repeated draws during the draw period |
| Repayment certainty | Higher; payment set at closing | Lower; payment can change |
| Common use | A one-time expense with a known cost | Expenses that are ongoing or uncertain |
Both products are secured by your home, so both put the property at risk if you fall behind. Both also require equity, and both generally involve closing costs unless the lender offers a no-cost version in exchange for a higher rate.
Interest, Payments, and Closing Costs
With a home equity loan, the interest rate and monthly payment are set when you close, so you know the full cost of the loan up front. With a HELOC, the rate is often variable and can change with the market, and the payment during the draw period may cover only interest. That difference matters most when comparing a short, defined project with spending spread over years.
Closing costs can include an application fee, an appraisal, a title search, and recording fees. Some lenders advertise reduced or waived closing costs, but those offers frequently come with a higher interest rate or a requirement to keep the line open for a minimum period. Ask for a written list of every fee before you commit.
Federal law gives you specific protections here. Under the Truth in Lending Act, a lender must disclose the annual percentage rate and other key terms before you sign, and for certain home-secured credit you have a right to cancel within a limited period after closing. The CFPB Regulation Z on Truth in Lending explains these requirements.
Comparing the annual percentage rate rather than the advertised rate is a better way to judge total cost, because the APR folds in many fees. Our guide to rate versus APR on a home loan explains the difference.
How Taxes Treat Home Equity Debt
Interest on home-secured debt is sometimes deductible, but the rules depend on what you did with the money. Under federal tax law, interest may be deductible when the loan is used to buy, build, or substantially improve the home that secures it; using the money for other purposes generally does not qualify. The IRS guidance on home mortgage interest describes the general rules, and a tax professional can speak to your situation.
Documentation matters. Keep records of how you used the funds, and confirm with the lender how interest will be reported. Tax treatment follows the use of the money, not whether it arrived as a lump sum or a line of credit.
The Risk of Using Your Home as Collateral
Because both products are secured by your home, missing payments can lead to foreclosure. That is the central difference between home equity borrowing and unsecured options such as a personal loan, where the lender's remedy is generally limited to collections and credit reporting rather than the loss of your house.
If you fall behind, the consequences appear on your credit reports. The CFPB credit report resources explain how to review your reports and dispute errors, and the Fair Credit Reporting Act sets the rules for what can be reported and for how long.
Be careful with offers that promise easy approval or pressure you to sign quickly; you should never sign documents you have not read. The FTC credit and loans guidance describes common warning signs.
Also weigh whether borrowing against the home is necessary at all. If the expense is small or short-term, a personal loan or a personal line of credit may accomplish the same goal without putting the property at risk.
How to Choose Between a HELOC and a Home Equity Loan
Work through these steps in order. They are designed to narrow the choice before you apply anywhere.
- Define the purpose and timeline. A single, known expense with a fixed end date points toward a home equity loan. Ongoing or uncertain costs point toward a line.
- Estimate available equity. Lenders look at your home's value, your remaining mortgage balance, and your credit profile. Our guide to home equity loan requirements covers the documents you will likely need.
- Compare total cost, not just the rate. Include closing costs, any annual or inactivity fees on a line, and the effect of a variable rate over time.
- Stress-test the payment. For a HELOC, estimate what the payment would be after the draw period ends, and whether you could handle a higher rate.
- Read the disclosures before signing. Confirm the rate structure, the draw and repayment periods, and any prepayment or early-closure penalties.
- Plan the exit. Decide now how you will repay the balance, whether by scheduled payments or a lump sum, and avoid treating the equity as spendable income.
If the line of credit format appeals to you but you would rather not use your home as collateral, compare it with a HELOC versus a personal loan. And before you commit, run the numbers with our home equity loan calculator to see how different terms affect the monthly payment.