Should you use a HELOC or home equity loan to consolidate debt?

All the time and care you’ve poured into your home does more than make it a comfortable place to live—it may also have helped you build equity. And that home equity— the value of your home above what you owe—could work for you in powerful ways. 

You don’t even need to sell your home to benefit from your equity. With a home equity loan or home equity line of credit (HELOC), you could leverage that equity to get a loan or credit line. That credit could then be used to reach financial goals like consolidating high-interest debt.

Both a HELOC and a home equity loan are types of secured credit that use your home as collateral. That means your home backs up the debt, and it could be sold by the lender if you stop making payments. Whether you go with a home equity loan or HELOC, have a plan to stay on top of your payments so you don't risk your home. 

Not sure which option is the best for you? Let's go over the key differences and when you might choose one option over the other.

Key differences between a HELOC and home equity loan

They may share similarities, but HELOCs and home equity loans often vary in a few important ways:

Loan structure

One important difference between a HELOC and a home equity loan is in the core structure: 

• A HELOC is a revolving credit line that you can draw from, repay, then draw from again, up to your credit limit. You can repeat this cycle as much as you need during the draw period.

• A home equity loan is a single-use loan. Once you've repaid your loan, the contract is over and the loan is done. If you want to borrow more money, you'll need to apply for a new loan.

Interest rates

Home equity loans usually have a fixed interest rate that stays the same for the duration of your loan. A HELOC could be a little more complicated.

You can get HELOCs with a fixed interest rate or a variable interest rate. Like a home equity loan, a HELOC with fixed rate will maintain the same interest rate the whole time you use your HELOC. With a variable-rate HELOC, your interest rate could go up or down with the market.

Access to funds

A home equity loan gives you the full loan amount at closing. With a HELOC, how you get the money can vary based on your lender.

Some HELOCs require taking the full amount out in one draw at the start. Others have a smaller initial draw requirement, then let you draw the rest of the funds later if you need them.

Repayment terms

A home equity loan is a simple installment loan. You'll get the full loan at once, then make regular monthly payments as set by the terms. Home equity loans can have a repayment term of up to 30 years. Each monthly payment will be the same amount, due at the same time every month.

A HELOC can be a little bit more complicated. Most HELOCs begin with the draw period, which is usually around 10 years. You can use the funds however you like during the draw period and make interest-only minimum payments if you choose.

Once the draw period is over, you enter the repayment period, usually around 20 years. During the repayment period, you'll need to make payments that include both the principal you borrowed and any accrued interest.

When is a HELOC a good option for debt consolidation? 

A HELOC could be a good choice for consolidating debt if you want flexible repayment terms. The interest-only payments during the draw period could be more manageable than the fixed payments of a home equity loan. This could give you time to get your finances stabilized before entering the repayment period when your monthly payment will go up.

When is a home equity loan a better fit for debt consolidation?

If fixed repayment terms are important to you, consider a home equity loan for consolidation. A home equity loan has the same payment due each month, which makes it predictable and easy to include in the budget. You'll also start paying down your principal right away, which could save you money on interest fees versus a HELOC with interest-only payments.

Choosing the best way to consolidate debt with home equity 

The best way to use your equity to consolidate debt will depend a lot on your specific needs. Here's what to consider:

• Repayment structure

• Type of interest rate

• Length of repayment 

• Future borrowing needs

Still not sure? You could chat with a loan expert to go over your options.

Scenario: HELOC vs. home equity loan for $40,000 of credit card debt

A good example is worth a lot. Let's imagine both Trisha and Sally each need to consolidate $40,000 in credit card debt. Each has multiple credit cards with an average interest rate of 25%. 

They're both currently paying about $1,200 a month just to cover the minimum payments. At that rate, they’ll need 40 years apiece to pay off their respective credit card debts.

Trisha chooses a home equity loan to consolidate her credit card debt. Sally opts for a home equity line of credit.

Trisha's home equity loan

Trisha's home equity loan has a fixed 13% interest rate and a 20-year term. She gets her $40,000 disbursed as a lump sum after closing. 

Trisha pays off her credit cards and starts making monthly payments. Her fixed terms mean she pays the same $470 a month for the next 20 years. Once she's done, her loan is finished.

Sally's HELOC

Sally's HELOC has a variable 13% interest rate, a 10-year draw period, and a 10-year repayment period. She initially draws $40,000 to pay off her credit cards. 

Sally makes interest-only payments for the first 10 years. Her variable interest rate changes a few times, so her monthly payment changes a little. On average, she pays $430 a month.

Once she enters the repayment period, Sally's monthly payment goes up. If her variable interest rate is still around 13%, she'll pay about $600 a month for the next ten years until her principal is paid off.

The results

Both Trisha and Sally cut their monthly debt payments by at least half by consolidating with home equity. They also both paid off their credit cards faster and for less money than if they'd made only their minimum card payments.