HELOC vs. Personal Loan: Which Is Better?

A HELOC and a Personal Loan Can Both Be Good Ways to Borrow, but the Right Choice Depends on Your Financial Needs

If you need to borrow money for debt consolidation, home improvements, or funding big purchases, you have several options. A home equity line of credit (HELOC) and a personal loan could both be good choices, but they work differently.

A personal loan is unsecured debt, which tends to come at a higher interest rate. A HELOC is secured by your home and functions as a line of credit that you can draw from during the draw period, or as a lump sum upfront payment that has additional draw options during the draw period.

There are pros and cons to both options, and the right choice depends on your needs. This guide will explain the key differences so you can decide which is best for you.

At a Glance: HELOCs vs. Personal Loans

The table below shows some of the key differences between a HELOC vs. a personal loan.

What Is a HELOC?

A home equity line of credit (HELOC) is a flexible loan secured by the equity in your home. It is a type of second mortgage, and the amount you can borrow depends on how much home equity you have, as well as your financial stability to afford the payments.

There is a lot of variation in HELOC products, so terms and conditions can vary.

Typically, when you get a HELOC, you are given access to a line of credit you draw from as needed, similar to a credit card but typically with a much lower interest rate. That rate may be fixed or variable.

HELOCS generally have a draw period (usually 5-10 years) and a repayment period (up to 20 years). You can borrow as much as you want (up to your credit limit) during the draw period.

With Freedom Mortgage's HELOC, you are given a lump sum up front, but also have the opportunity to take additional draws during the draw period, providing flexibility.

With some HELOCs, you're only required to make interest payments. This can lead to higher payments later. Freedom Mortgage's HELOC requires you to pay principal and interest from the start.

You can pay any type of HELOC off early to save on interest, but if you don't make payments, your loan could default and lead to foreclosure on your home.

What Is a Personal Loan?

A personal loan is an unsecured loan. You do not need equity in your home to qualify (in fact, you don’t need a home at all). Lenders provide an upfront lump sum amount, with the amount you can borrow based on your credit, income, and other financial factors.

The interest rate is almost always higher on a personal loan than on a HELOC, but you may be able to get faster funding, and upfront fees are usually lower. You'll usually have a fixed interest rate and pay back both principal and interest from the time you borrow.

Key Differences Between HELOCs and Personal Loans

Here are a few of the key differences between HELOCs and personal loans so you can decide which is right for you.

Collateral and Risk

A HELOC uses your home as collateral. This means if you don’t make payments, your home could go into foreclosure. This is why it’s very important to be able to comfortably afford your monthly HELOC payment before you choose one. You’ll save money with a HELOC, but they could have more personal risk (for you as a borrower) than a personal loan.

A personal loan does not have collateral. There's no asset guaranteeing the loan. If you don't make payments, your lender could try to collect by suing you and garnishing your wages or putting a lien on your home. Your credit score could also be negatively impacted as a result. Your risk can be much lower with a personal loan because your house isn't on the line.

Interest Rates

HELOCs are secured loans, which makes them less risky for lenders. As a result, they usually have lower interest rates than personal loans. HELOCs could have either a fixed rate or a variable interest rate, and your rate can change over the life of the loan if your rate is variable.

Personal loans are unsecured, so the rate is almost always higher than on a HELOC. Most personal loans have a fixed interest rate so you will know your payment and borrowing costs up front and those costs won't change over the life of the loan.

Borrowing Limits

The borrowing limit on a HELOC is based on the amount of equity you qualify for in your home.

Many lenders allow you to borrow up to 80% of the value of your home. This is across all your mortgages, so it includes your first mortgage and any other financial liens on your home. Interest rates are typically lower on HELOCs than personal loans since you are borrowing against your home equity.

The loan amounts available on personal loans vary by lender. Lenders may have maximum limits, such as $50,000 or $100,000 but your personal financial credentials, including income, debt, and credit score, will determine how much you can borrow.

Repayment Structure

HELOCs and personal loans also have different repayment structures.

With some types of HELOC, you borrow up to your credit limit and then make payments based on how much you've borrowed. During the draw period, you're allowed to make interest-only payments but must begin paying both principal and interest during the repayment period.

With Freedom Mortgage's HELOC, you make principal and interest payments from the beginning, but also have the opportunity to borrow more during the draw period. Your payments are based on the amount you have borrowed.

Personal loans allow you to borrow a lump sum, so you get the entire amount up front. You'll begin making payments right away, and your monthly payment will include both principal and interest. The amount of your payment won't change and is based on how much you must pay each month to repay your loan balance in full by the end of the loan term.

Personal Loan vs. HELOC Requirements

Here are some of the key differences in HELOC requirements vs. personal loan requirements.

• Home equity: Your home equity is critical to determine how much you can borrow with a HELOC. Usually, the combined value of your HELOC and original mortgage can't exceed 80% to 90% of your home’s value. Home equity is not required for a personal loan.
• Credit score: You may be able to qualify for an affordable HELOC with a lower credit score compared to the score requirements set by personal loan lenders. That's because a HELOC is less risky for lenders because it’s secured by a house.
• Debt-to-income ratio (DTI): Many lenders offering HELOCs set strict debt-to-income limits, while higher-interest personal loan lenders may be more flexible, especially for borrowers with strong credit.

HELOC vs. Personal Loan: Pros and Cons

When deciding between a HELOC vs. a personal loan, it's important to consider the pros and cons of both options. Here's what you need to know.

HELOC Benefits and Risks

The table below shows some of the biggest benefits and risks of a HELOC. Some of these pros and cons are potential, not guaranteed.

Personal Loan Benefits and Risks

There are also some pros and cons of personal loans to evaluate.

Is a HELOC or Personal Loan Right for You?

A HELOC may be the right choice if you have equity in your home, if you are confident you can afford payments, and if you want to qualify for a loan at a lower rate. If you want more borrowing flexibility, or you could benefit from interest-only payments that some HELOCs offer for the first 10 years, borrowing using a HELOC may be your best bet.

A personal loan could be a better option if you don't have home equity, if you want to borrow a smaller amount, and if you want funding quickly and with minimal upfront fees. If you want predictable payments and hope to pay off your loan in a shorter period of time, a personal loan may be a better fit.

Personal Loan vs. Home Equity Line of Credit FAQs

Still need to know more? Here are the answers to some frequently asked questions about a personal loan vs. a home equity line of credit.

Is a HELOC or Personal Loan Better for Home Improvements?

A HELOC can be a better option to fund home renovations if you qualify to deduct interest, if you want flexibility in how much and when you borrow, and if you want a lower possible interest rate. However, a personal loan is a better choice if you don't want a second mortgage on your home.

What’s an Alternative to HELOCs and Personal Loans?

There are several alternatives to HELOCs and personal loans. A cash-out refinance is a great option if you want to refinance your existing mortgage and borrow a lump sum up front. You may be able to benefit by lowering the rate on your existing mortgage, although refinancing could make financing charges longer over the life of the loan if you extend your repayment time.

A credit card is also another choice, although the interest rate will likely be variable, the interest rates will likely be higher, and borrowing limits will potentially be lower.

Is a HELOC or Personal Loan Better for Debt Consolidation?

A HELOC can be an affordable option to borrow for debt consolidation if the interest rate is lower than your current debt. However, if you don't have equity in your home, or don't want to get a second mortgage, a personal loan could be a better choice.

Final Thoughts: Deciding Between a HELOC and a Personal Loan

HELOCs are a great potential money-saving option if you're confident you can make payments, have equity, and want the lowest interest rate. Personal loans are an option if you don't have equity in your home, or don't want to borrow against your home, or want access to funds more quickly. You should consider the pros and cons of both to decide which is right for you.

If you've decided a HELOC is the best fit, reach out to Freedom Mortgage to apply for a HELOC today.