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HELOC vs. Personal Loan: Which is Better?

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HELOC vs. Personal Loan: Which is Better?

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When deciding between a home equity line of credit (HELOC) and a personal loan, consider how much money you need, the risk each type of loan presents and how you're going to spend the funds. A HELOC gives you access to a credit line and may offer tax advantages. A personal loan, on the other hand, could be a better option for one-time expenses or when you don't want to use your home as collateral.

What’s a HELOC?

A HELOC is a revolving line of credit and second mortgage. You'll use your home as collateral to get a HELOC, and the value of your home helps determine the maximum amount you can borrow against it.

Generally, the combined balance of your HELOC and other mortgage(s) can be 60% to 85% of your home's appraised value. For example, if your home is appraised at $400,000 and you owe $200,000 on a first mortgage, you might get a HELOC for $40,000 to $140,000. The exact amount can depend on the lender and your creditworthiness.

Borrowing against your HELOC is an option, not a requirement – although many lenders require an initial minimum draw that must be borrowed when the account is opened. You only pay interest on your draws, not the entire credit line. So, if you're approved for a $140,000 HELOC, for instance, you can choose to borrow just $25,000 of it without penalty.

Many HELOCs have an initial 10-year draw period when you can borrow against your credit line and make interest-only payments. Then, depending on the loan, you may need to make a balloon payment when the draw period ends. Or, you could have a fixed term, such as 20 years, to pay off the balance.

Pros

  • Large loans with potentially low interest rates
  • Only pay interest on what you borrow
  • Low monthly payments during the draw period
  • Interest payments may be tax-deductible if you use the money for home improvements

Cons

  • Application and approval process may take a long time
  • May require closing costs and fees, including annual, inactivity and early closure fees
  • Many HELOCs have variable interest rates
  • You risk losing your home if you can't afford to make payments

What’s a personal loan?

Personal loans are often unsecured installment loans with fixed interest rates and repayment terms. Loan amounts generally range from $1,000 to $50,000. However, some lenders, such as SoFi, offer personal loans for up to $100,000.

Because they're unsecured loans, your eligibility, loan amount and interest rate will largely depend on your creditworthiness. But even for the most creditworthy applicants, personal loans tend to have higher interest rates than HELOCs.

You can use a personal loan to pay for almost anything. Common uses include paying for emergency expenses, medical bills, large purchases and consolidating higher-rate debts.

You can also get a personal loan for home improvements, and it may be the best option if you don't have enough home equity for a HELOC or don't want to use the equity in your home. Unlike with a HELOC, however, the interest you pay on a personal loan will never be tax-deductible.

Pros

  • You don't need collateral
  • Offers a potentially low interest rate
  • The fixed interest rate limits risk
  • You can often get the funds within several business days

Cons

  • Good credit is typically required to get a loan with a low interest rate
  • The loan amount you're approved for might not cover your expenses
  • Some lenders charge origination fees
  • No tax advantages

HELOC vs. Personal Loan – What's best?

A HELOC could be a better option if you need to borrow a substantial amount of money or have an ongoing project that’ll require several draws. The low interest rate can also make HELOCs an inexpensive option. However, there's risk in using your home as collateral, and there's the possibility your rate will rise.

A personal loan could be best for a one-time expense, particularly if you qualify for a low-rate loan and won't benefit from tax deductions from a home improvement loan. It's also easier to get a personal loan, and it may be cheaper in the short run as you don't have to pay closing costs and there may be fewer fees.

Alternatives to HELOCs and Personal Loans

You can also look into different types of financing. These may be better fits depending on your creditworthiness and how you plan on using the funds.

alternatives
Credit cards While credit cards have high interest rates, some cards have introductory 0% interest rate offers for new cardholders. The credit limit might not be high enough for large expenses, but you won't accrue interest during the promotional period
Personal line of credit A personal line of credit is similar to an unsecured HELOC. For ongoing projects, you'll be able to take draws and only pay interest when you borrow money. Some lenders, such as Upgrade, offer personal lines of credit with linked cards you can use for purchases
Cash-out refinancing With a cash-out refi, you'll refinance your mortgage with a larger loan and get the difference in cash. It can have the added benefit of lowering your mortgage's interest rate in the process. Keep in mind, though, the larger loan amount means your monthly payment will likely increase

Check your credit score first

Whether you're looking for a HELOC, personal loan or other form of financing, your credit score can play an important role in determining your eligibility and interest rate. Check your credit score for free with Experian, and get insights into which factors are most impacting your score. Improving your score before applying may help you get a loan with more favorable terms.