In a Nutshell
If you need cash for upcoming or ongoing expenses, you may have considered a HELOC or a personal loan. Both can help you with financial goals like home improvement or debt consolidation, but the best one depends on your goals and financial circumstances.If you need money for larger financial goals like debt consolidation or home improvements, you may be considering a personal loan or home equity line of credit.
While both can be good borrowing options, it’s important to understand the difference between them to choose the one that works best for your financial situation.
A home equity line of credit, or HELOC, is secured by your home, while a personal loan is typically unsecured and lending is based largely on your credit and income.
In this article, we’ll review the pros and cons of HELOCs and personal loans to help guide you through the decision-making process.
What are the main differences between a HELOC and a personal loan?
The main difference between a HELOC and a personal loan is how they are typically secured and what this means for your loan terms.
A HELOC is a line of credit that uses your home equity as collateral. A personal loan is typically an unsecured loan, meaning it’s not backed by any collateral.
In most cases, your possessions aren’t immediately at risk if you default on a personal loan. In some cases, however, a personal loan lender could sue you for nonpayment of debt, which could mean your assets are at risk. Your wages could be garnished or a lien could be placed on your home to satisfy the unpaid debt.
Typically, unsecured personal loans have a higher interest rate than secured debt, but that’s not the only difference between a HELOC and a personal loan. Let’s take a look at other ways these loans differ from one another.
| HELOC | Personal loan | |
|---|---|---|
| Interest rate | Usually variable | Usually fixed |
| Collateral | Your home | None if unsecured |
| Max. loan amount | Up to $1 million | Up to $100,000 |
| Repayment options | Principal + interest or Interest-only | Fixed amounts (equal installments) |
| Potential fees | Closing + origination costs, prepayment penalties, draw fees, annual membership fees | Origination or administrative fees, late fees |
| Tax advantages | Interest may be tax-deductible for qualifying years and uses | None |
Interest rates
HELOCs typically have lower interest rates than personal loans, but the interest rate is often variable, which means it may go up — or down — over time. A HELOC is a revolving line of credit, so like a credit card, you’ll only pay interest on your outstanding balance.
For instance, if you have a $50,000 line of credit but are using only $4,000 of your credit limit, you’ll only owe payments and interest on the $4,000.
Unsecured personal loans don’t require security or collateral and have fixed interest rates and payment amounts. Unlike a line of credit, you’ll borrow a lump sum upfront and can count on the terms being constant for the life of the loan.
Qualifications
Like any other loan, qualifying for a HELOC or personal loan means you must meet the lender’s requirements on criteria such as credit, income and debt-to-income ratio.
With a HELOC, you must meet the lender’s financial requirements and own a property that you can borrow against. You’ll also need enough equity in your home — often no more than 85% of your home’s worth (minus what you owe on your mortgage).
For instance, if your home is worth $400,000 and you owe $250,000 on your mortgage, the maximum you may be able to borrow would be $90,000.
Collateral
Personal loans are usually unsecured and don’t require collateral. For this reason, your interest rate is typically higher than it would be with a HELOC because the lender sees it as a greater risk.
A HELOC, however, is secured by your home, so defaulting on this loan could put your home at risk of foreclosure.
Loan amounts
Lenders offer personal loans anywhere from $1,000 up to $100,000, though many lenders cut off their maximum loan amounts closer to $50,000. The stronger your credit, income and overall financial profile, the better chance you’ll have of qualifying for a larger loan with competitive rates.
Because HELOCs are tied to your home’s equity, the loan amounts are often higher than they are with personal loans. For instance, some lenders offer HELOCs up to several hundred thousand dollars and, in some cases, up to $1 million.
Although you can finance home improvements with a personal loan, you may not qualify for as much money as you would with a secured debt like a HELOC.
Repayment terms
The repayment terms on personal loans are pretty straightforward. You’ll usually have a fixed payment that covers the principal and interest portion of the loan. These terms are the same for the entire loan term (length of the loan.)
Your lender may offer different options to repay your HELOC. One option is to make payments that cover the principal and interest on the outstanding balance.
Another option is an interest-only payment, which will not pay down your loan’s principal. Keep in mind if you choose this option, your monthly payment can increase a lot once you hit the repayment period.
Some lenders may let you convert your repayment plan to a fixed-term installment loan.
Fees
Both HELOC and personal loans often come with fees. With HELOCs and personal loans, you could be on the hook for origination fees and other costs. Some personal loan lenders waive these fees, but you should be aware of lender fees so you know exactly what you are paying for on your loan.
A HELOC may have closing costs and other fees that could include one or more of the following:
- Appraisal fee
- Application
- Points
- Attorney fees
- Title search fees
- Document fees
- Taxes
- Annual fee or account maintenance fee
Some lenders may choose to waive a portion or all of the fees for a HELOC.
Tax incentives
The interest you pay on a HELOC may be tax deductible for qualified uses, while the interest on a personal loan is not.
Keep in mind that there are restrictions on receiving tax deductions for the interest you pay on a HELOC, though. You’ll need to use the money to make improvements to your home.
To learn more, it’s a good idea to consult a tax professional who can provide specific guidance for your situation.
Credit risk for default
If you default on a personal loan, this can harm your credit. Additionally, your assets won’t be immediately at risk.
With a HELOC, default is different. The lender may have the right to foreclose on your home if you default on your loan. Additionally, this activity may be reported to the credit bureaus and appear on your credit reports.
Is a personal loan better than a HELOC?
HELOCs and personal loans both have pros and cons, but which one suits you best will depend on the amount of money you need and the purpose of the loan.
Here are times when you might consider a personal loan or a HELOC.
Personal loan
- Consolidating high-interest debt
- Covering a cosmetic procedure like braces or tattoo removal
- Paying for a wedding
HELOC
- College tuition and expenses
- Ongoing home improvement projects
- Debt consolidation
A personal loan is ideal for smaller expenses you don’t plan to encounter often. A HELOC could be best for ongoing expenses that allow you to pay down and reuse the line of credit over an extended period of time.
What’s next?
No matter what you choose to do, it’s smart to compare offers from multiple lenders before making a decision. Shop around for the best interest rate and terms that fit your needs. Calculate the total interest you’ll pay with both options — don’t only consider the monthly payment.
Whether you opt for a personal loan or a HELOC, it’s important that you understand the risks and benefits before signing on the dotted line.