Which of these two borrowing options are best for your needs?
When you’re looking for financing, you’ll find options to fit most any situation or goal. Among your options are personal loans and home equity lines of credit (HELOCs).
Both can get you the money you need, but with key differences that involve your personal assets and overall financial security. Here’s how to compare them to determine which is right for you.
How do personal loans differ from HELOCs?
- Whether they require collateral. Personal loans are unrestricted funding to use however you please without the hassle of putting up collateral. Most personal loans are unsecured, while you can find some lenders offering secured personal loans at slightly lower interest rates. As its name implies, a home equity line of credit is secured by the equity you’ve built up in your primary residence. Because you’re borrowing against your home’s equity, how much you can get depends on that equity. For example, if you’ve built up $150,000 but still owe $200,000 on your mortgage, the most you could qualify for with a HELOC is $150,000, though it might even be 80% to 90% of that amount.
- How you can access funds. With a personal loan, a lender disburses your approved funding in one go. With a HELOC, you’re approved for a specific amount, but you take from it only what you need as you need it during a “draw period” — the window of access to your funds, which can last up to 20 years depending on your loan terms. You can usually just make interest-only payments during the draw period. After this period is over, the repayment period begins and you have to pay off the principal of the HELOC along with the interest.
- Your interest rates. Personal loan options include both predictable fixed rates and variable rates that fluctuate over the life of your loan. HELOCs come with only variable rates: You might start with a low interest rate — and possibly interest-only payments during your draw period — but your rate will fluctuate over your repayment term. As will your monthly payments. This is because a HELOC’s interest rate is determined by the prime rate plus the margin designated by your bank or lender.
- How you repay the loan. Personal loans come with monthly repayments that include your principal and interest over a specified time. With a HELOC, you make monthly repayments only for the amount you withdrew during the draw period. You might have the option of repaying interest only during your draw period, but this depends on your specific HELOC.
Quick snapshot: Four ways personal loans and HELOCs differ
|Collateral||None, unless specifically applying for a secured loan||The equity you have in your home|
|Access to funds||Direct deposit to bank account from lender, all at once||Approved funds can be taken as needed during draw period|
|Interest rate||Fixed rate or variable rate depending on the lender||Variable rate only|
|Repayment terms||Monthly repayments, including your principal and interest over a specified time||Monthly repayments, only for the amount you withdrew during the draw period|
What are the benefits of personal loans and HELOCs?
- Collateral not required. You won’t need to secure your personal loan with assets like your home or car.
- Simple application. Your typical personal loan is easy to apply for and requires far less paperwork and time required for a HELOC.
- Quick turnaround. Depending on your lender, you could begin using your loan in just a few days.
- Typically lower initial rates. Because your home’s equity effectively secures what you borrow, your initial interest rate can be decent. But your rate is variable, which means rising prime rates ultimately affect how much you pay each month.
- Borrow only what you need. During your HELOC’s draw period, you withdraw only what you need up to your approved limit.
- Tax-deductible interest. Like the interest you pay on your mortgage, you can usually deduct your HELOC’s interest from your taxes.
- Longer loan terms. You’ll see some HELOCs with repayment terms of up to 20 years — far longer than your typical personal loan.
What are the drawbacks of personal loans and HELOCs?
- Higher interest. While personal loans tend to come with lower interest than credit cards, the rates are noticeably higher than those offered through HELOCs.
- Typically lower maximums. While you’ll find a few banks and online lenders willing to lend you up to $100,000, personal loans typically top out at $50,000.
- Good to excellent credit required. The more you want to borrow, the higher the credit score you should have. Your score will significantly influence how much you get and the loan’s APR.
- Limited to homeowners. A perk of homeownership is borrowing against the equity you’ve so carefully built up in your home. If you don’t own a home, this option is off the table.
- Interest rate tied to prime rate. When the Fed raises the prime rate, your interest rate will go up — which can dramatically affect how much you pay each month.
- Long application process. To establish equity, you need a home appraisal, on top of the many fees and waiting period you’ll find with any mortgage.
- You could lose your home. It’s not called a second mortgage for nothing. Because you’re essentially taking out credit secured by a lien on your home, if you default, you could lose your house to foreclosure.
- More fees. HELOCs can require an appraisal fee, an application fee and even annual maintenance fees over your repayment term. Confirm all fees you face with your specific HELOC before signing a contract.
Which borrowing option is better suited for me?
If you’re looking at borrowing a lot of money and you own a home, a HELOC can get you a low initial rate and longer repayment terms than you’ll find with your typical personal loan. But you’ll need to confirm that you’ve built up enough equity in your home to cover the amount you need.
If you don’t own a home or don’t want to risk its equity, a personal loan can offer predictable monthly payments at fixed or variable rates and terms to suit most any need.
When deciding between a personal loan or a HELOC, it comes down to how much money you’re looking for and whether you have the home equity to support it. No matter which you ultimately choose, pay close attention to your specific repayment terms before signing a contract.
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