What’s the Difference Between a HELOC and a Personal Loan?
The main difference between a HELOC and a personal loan is the collateral the financial institution will require for the loan. HELOCs use the borrower’s home as backup in case the borrower defaults. Personal loans often don’t need collateral, and this fact affects the way the two loan types are structured, including interest rates, repayment terms, loan amounts, and fees charged. This variance also can determine whether the borrower qualifies for certain tax incentives.
Collateral
The most impactful difference between a HELOC and a personal loan is the collateral required. A HELOC assigns the borrower’s home as collateral, but most personal loans require no collateral. Some larger personal loans may mandate some type of collateral, such as a car or savings account, but that’s rare.
Available Loan Amounts
Because a HELOC is based on the equity in the borrower’s home, this type of loan allows for larger borrowing limits than personal loans. Most lenders have a maximum percentage of the home value they are willing to make available. HELOCs typically range from 75% to 85% of the home’s value, minus whatever balance is owed, making it possible to have access to hundreds of thousands of dollars. For example, if a house is valued at $600,000, the lender may decide to offer 75% of the value, or $450,000. The lender would then subtract the remaining balance the homeowner owes on the house. In this case, let’s say the homeowner still owes $300,000. If the homeowner is approved, the lender would issue a HELOC for $150,000. Similar to a credit card, HELOC withdrawals can be made in increments and taken at any time throughout the draw period, which is usually 10 years. Personal loans are taken in one lump sum, and typically grant lower amounts than HELOCs. Personal loans can be for any amount, but most often range between $1,000 and $100,000.
Repayment Terms
As mentioned, HELOCs are structured like a revolving credit line. The borrower is only required to repay the interest on the amount borrowed during the draw period—usually 10 years—instead of on the entire available credit amount. Much like a credit card, HELOC payments must be made monthly, until the total balance is paid off or until the end of the draw period. After the draw period ends, the borrower can no longer withdraw funds, and they will be responsible for making payments on the balance that remains. HELOC payments that formerly included only interest will be amortized and include interest as well as the principal balance. Borrowers will continue to make payments until the repayment period ends, typically 20 years. Personal loans, on the other hand, are fairly straightforward and are repaid in equal installments shortly after the lump sum is disbursed, often in two to five years. Personal loan payments are made on the account until the entire balance is paid off.
Taxes
One benefit HELOC borrowers find helpful is the tax incentives offered for some uses. Borrowers who withdraw HELOC funds for a home purchase or home improvement may be able to deduct the interest payments on their tax returns. However, the HELOC must be secured by a primary residence to qualify.
Fees
Loan fees can be a concern for any borrower looking to keep costs under control. Although some major banks offer HELOCs with no closing costs, such a loan’s likely administrative costs are a borrowing expense to consider. HELOC fees can comprise origination costs, title fees, and the cost of appraising the home. Personal loans usually have fewer fees than HELOCs, but origination costs are common. Any origination fees are set upfront and calculated into the loan balance. Some personal loans penalize borrowers for paying balances off early; however, most do not.
Credit Impact
Both HELOCs and personal loans typically are reported to one or more of the three major credit bureaus when obtained, and missed payments can negatively impact credit scores with either type of loan. As discussed, personal loans are unsecured, so non-payment primarily will result in damaged credit.
Which Is Right for You?
HELOC and personal loans both have pros and cons, but which suits you best will depend on the amount of money needed and the purpose of the loan. For those seeking a small sum, a personal loan can mean less paperwork and be easier to qualify for. If you’re a potential borrower with home equity who wants a larger amount of money, you may be better off opting for a HELOC. HELOCs work best for people who:
Have equity in their homesWant flexibility in loan withdrawal amountsDon’t mind a loan with a variable interest rateNeed larger amounts for a home purchase or home improvementDon’t necessarily need funds now, but would like an additional line of credit in case of emergencies
Personal loans may be the best option for people who:
Are looking for a lump-sum disbursementWant a simple application processWant a fixed-rate installment loan with payments that stay the same every monthNeed a significant loan but don’t own a home or have enough equity for collateralSeek a relatively small loan of a few thousand dollars
The Bottom Line
The main differences between HELOCs and personal loans are the collateral required and the interest rates you’ll have in repayment. While HELOCs offer homeowners a way to access equity whenever they need it, the variable rate could mean rising monthly payments and a tighter budget in the future. Despite the appeal of a personal loan’s fixed interest rate, borrowers could be locked into a higher rate upfront, with loan terms that strain their budgets. Regardless, it’s crucial to shop around and review the loan terms that work best for your situation. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
