HELOC vs Home Equity Loan: Which is Better During Inflation?

If you’ve noticed that your paycheck doesn’t go as far as it used to, it could be the result of inflation. In the U.S., the Consumer Price Index increased 3.7% over the year ending September 2023.

To combat this dramatic rise, the Federal Reserve has been steadily increasing interest rates (though they are expected to finally even out or decrease in 2024). These elevated interest rates have had a notable impact on the affordability of many types of financing, including home equity lines of credit (HELOCs) and home equity loans.

If you’re wondering whether you should take out a HELOC or home equity loan in today’s inflationary climate, you’re in the right place. Below, we’ll compare each financing option’s pros and cons and suggest some tips to score the lowest rate.

What is a HELOC?

A HELOC is a line of credit that allows you to borrow money against the equity of your home. Equity is the difference between your home’s current market value and your outstanding mortgage balance. The longer you’ve lived in your home and paid on your mortgage, the more equity you’ll typically have available.

Here are some key features of HELOCs:

Revolving line of credit – As revolving lines of credit, HELOCs let you borrow money as needed up to a set credit limit. Once you reach your credit limit, you must pay down some of your balance before using your HELOC again.
Variable interest rates – Like credit cards, HELOCs come with variable interest rates, which fluctuate in response to changing economic conditions. However, compared to credit cards, HELOC interest rates in general are lower, making them an attractive alternative to financing home projects with a credit card.
Two repayment periods – HELOCs have two different repayment periods. The draw period is when you get to borrow money using your HELOC. It typically lasts between five and 15 years. During the draw period, you’re only required to make interest payments on your outstanding balance. Once the draw period is over, the repayment period begins and lasts anywhere from 10 to 20 years. During this time, you’ll have to pay down your outstanding balance, plus interest, in monthly installments.

You can apply for a HELOC from a bank, online lender, or credit union. Just keep in mind that credit unions often offer the lowest interest rates. That’s because they’re not-for-profit institutions. Rather than pocketing their surplus earnings, they use them to reduce their members’ interest rates instead.

What is a Home Equity Loan?

Like HELOCs, home equity loans let you borrow money from your equity. The difference is that home equity loans function like traditional loans, rather than lines of credit.

As a result, you can expect the following features from your home equity loan:

Fixed loan amount – A home equity loan lets you borrow a lump sum of money all at once.
Fixed interest rates – Home equity loans typically come with fixed interest rates. These interest rates remain the same for the entire duration of your loan term.
One repayment period – As soon as you receive your home equity loan, you’ll enter a repayment period of five to 30 years. During this time, you’ll make regular monthly payments.

As with HELOCs, credit unions typically have the most affordable home equity loans. What’s more, they’re often willing to provide more flexible repayment terms and personalized customer service than their big bank counterparts.

Borrowing Factors to Consider During Inflation

Now that you know the basic differences between HELOCs and home equity loans, you may be wondering how inflation impacts each of them.

Inflation, which is defined as the sustained increase in the prices of goods and services over time, can impact both HELOCs and home equity loans in the following ways:

Higher interest rates – As noted earlier, the Federal Reserve often raises interest rates to curb inflation. Thus, if you take out your HELOC or home equity loan during an inflationary period, you may receive a higher interest rate than you would otherwise.
Greater borrowing ability – Along with other economic factors, inflation can increase your home value, enabling you to borrow more money using your HELOC or home equity loan.

As you can see, inflation has short-term benefits and drawbacks for HELOCs and home equity loans.

Pros and Cons of HELOCs vs. Home Equity Loans During Inflation

So, should you apply for a HELOC or home equity loan? You can use the following pros and cons to guide your decision-making process.

HELOC Pros and Cons

Pros:

Flexibility – HELOCs let you borrow money as needed, rather than requiring you to commit to a large lump sum. As a result, you can borrow exactly what you need and keep your interest fees to a minimum.
Variable interest rates – While your HELOC’s interest rate may be elevated during times of inflation, it will likely decrease once inflation cools down. Thus, the timing of your HELOC application is not as important as it is with a home equity loan.

Cons:

Less stability – While your HELOC’s interest rate may decrease in the future, there’s no way to predict when this will take place. Additionally, inflation could pick up again in the future, increasing your interest rate and monthly payments once again.

Home Equity Loan Pros and Cons

Pros:

Predictability – When you take out a home equity loan, you know exactly how much you’ll owe each month for the lifetime of the loan. In turn, you can map out your long-term monthly budget with confidence.

Cons:

Less flexibility – If you don’t use all of the money from your home equity loan, you may end up paying interest on unnecessary funds.
No possibility for a lower rate – Home equity loans taken out during inflation will maintain their elevated interest rates for their entire duration.

Make an Informed Decision With CUSelect

Based on these pros and cons, HELOCs may be a more attractive method for borrowing during inflation. However, the right choice ultimately depends on your intended use, risk tolerance, and financial situation.

If you want more personalized support, reach out to your local credit union. They can help you select the right type of financing and secure a competitive rate.

Ready to find a credit union near you? Utilize CUSelect to locate a credit union lender.