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Deciding between an equity line of credit and a personal loan can be tricky. Both allow you to access cash for major expenses, debt consolidation, home renovations and more. But there are some key differences you’ll want to consider before choosing one option over the other.
In this comprehensive guide, we’ll cover everything you need to know to make an informed decision on whether an equity line of credit or personal loan is better for your financial situation I’ll break down the pros and cons of each, look at interest rates, fees, qualifications, uses and more.
What is an Equity Line of Credit?
An equity line of credit (also called a home equity line of credit or HELOC) allows homeowners to borrow against the equity they’ve built up in their home
It’s a revolving line of credit, which means you have access to a set borrowing limit that you can draw from as needed. You only pay interest on the amount you actually use.
With a HELOC, you can borrow up to 80-85% of your home’s value minus what you owe on your mortgage. So if your home is worth $300,000 and you owe $150,000 on your mortgage, you could qualify for a HELOC up to $120,000-$135,000.
HELOCs have variable interest rates tied to a benchmark like the prime rate. This means your interest rate and monthly payments can fluctuate over the life of the loan.
Repayment terms on HELOCs are usually 10-20 years. During the draw period, which typically lasts 5-10 years, you can access funds as needed. After the draw period ends, the account converts to a repayment plan where you can no longer draw funds and must start making principal and interest payments on the full balance.
What is a Personal Loan?
A personal loan provides a fixed amount of money upfront that’s repaid in fixed monthly installments over a set repayment term.
Personal loans are unsecured, meaning they aren’t tied to any collateral. Qualification is based on your creditworthiness and income.
Loan amounts on personal loans often range from $1,000 to $100,000, though some lenders offer higher amounts. Terms are generally between 1-7 years.
Interest rates on personal loans are fixed, meaning your rate and monthly payments won’t change. Rates are often quite high compared to secured loans, commonly starting in the double digits for borrowers with good credit. You’ll pay higher rates if your credit score is fair or poor.
Key Differences Between HELOCs and Personal Loans
Now that you understand the basics of equity lines of credit and personal loans, let’s take a closer look at how they compare across some key factors:
Loan amount
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HELOCs allow you to borrow 50-85% of your home’s value minus your mortgage balance. So available loan amounts are often quite high, sometimes over $100,000.
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Personal loan amounts range from $1,000 to $100,000 in most cases. Some lenders offer higher loan amounts up to $150,000 or more.
Interest rates
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HELOCs have variable rates tied to an index like prime. Rates start relatively low, often between 3-6% for prime borrowers.
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Personal loans have fixed rates that don’t change. Rates commonly start above 10% for borrowers with good credit and go up from there.
Fees
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HELOCs often charge closing costs between 2-5% of the loan amount. There may also be annual fees.
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Many personal loans charge no upfront fees. Some lenders may charge origination fees.
Collateral
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HELOCs require you to use your home as collateral. This gives lenders the right to foreclose if you default.
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Personal loans are unsecured, so you don’t put any valuable assets at risk if you default.
Qualification
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To qualify for a HELOC you’ll generally need a credit score of at least 620 and sufficient home equity.
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Personal loans have minimum credit scores around 560-670, but you’ll pay very high rates with lower scores. Strong income helps.
Repayment term
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HELOCs give you 10-20 years to repay the balance after the 5-10 year draw period.
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Personal loan terms are much shorter, usually 2-7 years.
Time to funding
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It can take 3-6 weeks to close a HELOC because of required appraisals.
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Personal loans provide funding in as soon as 1-7 days in many cases. No appraisal is required.
Pros and Cons of HELOCs
Pros
- Lower interest rates than personal loans
- Large borrowing capacity
- Pay interest only on what you use
- Interest may be tax deductible
Cons
- Home is at risk if you default
- Closing costs and fees
- Rates can rise over time
- Lengthy application process
- Repayment period only starts after the draw period ends
Pros and Cons of Personal Loans
Pros
- Quick access to funds
- Fixed rates and payments
- No home equity required
- Can get with fair credit
- No prepayment penalties
Cons
- Higher rates than home equity loans
- Lenders review credit heavily
- Limited loan amounts
- Short repayment terms
When a HELOC Makes Sense
HELOCs shine when you:
- Need to finance a large purchase or project over $50,000
- Want to consolidate high interest debts like credit cards
- Have sufficient home equity and good credit
- Will deduct interest for home improvements
- Can manage variable rates
Common uses for HELOCs include:
- Major home renovations
- College tuition
- Weddings
- Debt consolidation
- Emergency funds
When a Personal Loan is the Better Option
Consider a personal loan if you:
- Need a smaller loan under $50,000
- Don’t want to tap home equity
- Have limited home equity
- Need funds quickly
- Are looking to establish credit history
Personal loans work well for:
- Small home repairs and renovations
- Car repairs
- Medical bills
- Moving expenses
- Vacations
- Consolidating credit card balances
- Building credit
Key Takeaways
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HELOCs provide lower rates and bigger loan amounts but put your home at risk. Closing costs also apply.
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Personal loans are quick, easy to qualify for and don’t use home equity, but have higher fixed interest rates.
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HELOCs make sense for big projects while personal loans suit smaller borrowing needs.
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Compare rates and terms from multiple lenders to find the most affordable option for your situation.
The bottom line is there’s no one-size-fits-all answer to whether a HELOC or personal loan is the better choice. Consider your specific financial situation, credit profile, planned use of funds and comfort with debt to decide which option makes the most sense for you.
How personal loans work
Personal loans are a type of credit offered by banks and credit unions as well as online lenders. They can be used to cover almost any expense, but common uses include debt consolidation, emergency costs, moving, large purchases and recreational vehicles, like boats.
Loan proceeds are disbursed in a lump sum and payable with interest in equal monthly installments. Most repayment periods span one to seven years, but some lenders offer shorter or longer terms.
Borrowers with good to excellent credit are more likely to be approved for a low rate, which lowers the total cost of the loan. Despite that, there are quite a few lenders that work with borrowers with poor credit.
The application process is typically done online and requires basic personal and financial information. You should compare multiple lenders to find the best deal.
- Flexibility: There are usually minimal to no usage restrictions on personal loans.
- Fast funding times: Personal loans can be approved and funded as soon as the next business day while home equity loans can take weeks.
- No collateral required: Most personal loans are unsecured, so you won’t be at risk of losing your assets if you fall behind on payments.
- High interest rates: Interest rates for personal loans are typically lower than credit cards, but higher than home equity loans.
- Lower funding amounts: Personal loans are generally capped at $100,000.
- Shorter term lengths: The maximum repayment period for a personal loan is usually seven years, compared to up to 30 years for home equity loans.
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- Personal loans and home equity loans can provide a much-needed source of funding if you need cash.
- Personal loans are less risky as they’re unsecured, but they often come with higher interest rates.
- Home equity loans are more accessible to borrowers with lower credit scores, but you could lose your home if you fall behind on payments.
- You may have access to a higher loan amount with a home equity loan as it’s based on your ownership stake.
Personal loans and home equity loans can be used for
Another big difference is that personal loans are unsecured, while home equity loans are secured and use your home as collateral. Consequently, deciding which one is best for your financial situation can be challenging as they both come with significant benefits and drawbacks.
HELOCs vs Personal Loans
What is a personal line of credit & a home equity loan?
A personal line of credit is a type of revolving credit that works similarly to a credit card, and a home equity loan is a lump-sum loan for homeowners. Personal lines of credit and home equity loans are both ways to borrow money.
What is the difference between a personal loan and a home equity loan?
Personal loan term lengths are typically more flexible than with home equity loans. Interest rates are fixed and typically somewhere in the 6% – 36% range, depending on your credit score and other factors. You don’t need to own a home or have sufficient equity. Monthly payments are fixed and predictable.
What is the difference between a HELOC and a personal loan?
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. Looking for a HELOC? Compare Options Now
Should you get a home equity loan or a personal loan?
Most lenders will let you borrow up to 85 percent of your home’s combined loan-to-value ratio. A home equity loan has one big advantage over a personal loan: lower interest rates. But because the loan uses your home as collateral, the lender has built-in recourse if you default on payments — specifically it can foreclose your home.