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. Two of the most popular otpions 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.
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Quick snapshot: 4 ways personal loans and HELOCs differ
| Personal loan | HELOC | |
|---|---|---|
| Collateral | Depends on whether you choose a secured or unsecured loan | HELOCs use the equity of your home as security |
| Access to funds | Direct deposit to your bank account from the lender | Approved funds can be taken as needed during the draw period |
| Interest rate | Fixed rate or variable rate depending on the lender | Variable rate |
| 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 |
How do personal loans differ from HELOCs?
There are some major differences between personal loans and home equity lines of credit. When you’re looking to borrow, keep these major points in mind.
Is collateral required?
Whether or not you need collateral depends on the type of loan you’re looking to borrow. Unsecured loans don’t require any collateral while secured loans do. While you may not want to risk losing your collateral if you default, secured loans may save you money by charging lower interest rates.
A home equity line of credit is secured by the equity of your primary residence. This is the collateral for your loan. And because it’s secured, you may be charged even lower interest rates than you would with a secured personal loan.
How are funds disbursed?
With a personal loan, a lender disburses your approved funding in one go.
In most cases, funds are disbursed directly to your bank account a week or two after you complete your loan agreement.
With a home equity line of credit, 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. This can last up to 20 years.
How is interest calculated?
Your interest will vary based on your loan terms. Some personal loans have fixed interest rates, meaning you pay the same amount every month. Others have variable rates which change based on market conditions and the Prime Rate published by the Wall Street Journal.
Lenders usually only have variable rates available for HELOCs. You might start with a low interest rate — and possibly interest-only payments during your draw period — but your rate and monthly payment will fluctuate over your loan term. This is because a HELOC’s interest rate is determined by the Prime Rate plus the margin designated by your bank or lender.
How is the loan repaid?
Personal loans come with monthly repayments that include your principal and interest over a specified time. Some lenders will even offer rate discounts if you sign up for autopay.
With a HELOC, you make monthly repayments only for the amount you withdrew during the draw period. You might even have the option of repaying only interest during your draw period.
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What are the benefits of personal loans and HELOCs?
Personal loans
- Collateral not required. You won’t need to secure your personal loan with assets like your home or car. There are plenty of unsecured personal loan options available.
- Simple application. Your typical personal loan is easy to apply for and requires far less paperwork and time than a HELOC.
- Quick turnaround. Depending on your lender, you could receive your loan funds in just a few days.
HELOCs
- Typically lower initial rates. Because your home’s equity effectively secures what you borrow, your initial interest rate may be lower than with a personal loan.
- 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 tax implications of personal loans?
What are the drawbacks of personal loans and HELOCs?
Personal loans
- 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.
HELOCs
- 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. 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 loan term.
Which borrowing option is better suited for me?
If you own a home, want to borrow a significant sum of money and are willing to use your property as collateral, 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.
Bottom line
When deciding between a personal loan or a HELOC, it comes down to how much money you’re looking for and if 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.
You can compare your personal loan options against your home equity options to see which proves to be the better deal for your budget.
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