HELOCs versus Personal Loans: Which Makes More Sense for You?

There are times in life where you might find yourself needing access to more cash than you currently have on-hand. Whether you’re planning a big home renovation project, encounter an unexpected expense, or just want to consolidate your existing debt balances, borrowing money could be a great way to accomplish your financial goals. 

Personal loans and home equity lines of credit (HELOCs) are two options for accessing the funds you need. While similar in some ways, they each work a bit differently and offer unique benefits for borrowers.

Here’s everything you need to know about HELOCs versus personal loans, and how to choose which is the right one for you and your situation.

Understanding HELOCs

A HELOC is a home equity line of credit, or a loan against the established equity in your home. This line of credit works similar to a revolving credit card: you can choose to pull from your line of credit as needed during the draw period, and for nearly any purpose. 

If and when you do borrow against that line of credit, you will be required to make monthly payments on the debt according to the outstanding balance. HELOCs tend to have variable interest rates, so the APR on your debt can change over time based on market conditions and other factors, though some HELOC lenders may offer fixed rate options.

If you never borrow against your HELOC, you’ll never have a payment due (although some lenders may charge annual maintenance fees). Additionally, a HELOC has a defined draw term, or a period of time during which you can borrow against the line of credit. After that draw period ends, you will enter the repayment period where you are required to make principal and interest payments until the full amount borrowed is repaid. 

If you want to continue borrowing against your home equity once your HELOC’s draw period ends, you will need to renew your line of credit. Not all lenders will allow you to renew the credit line, however, so this option is not guaranteed and your options may vary by scenario.

The amount you can borrow with a HELOC depends on a number of factors, including:

• How much equity you have, or the difference between what your property is worth and how much you still owe to your mortgage lender

• Your credit score and history

• Your income

• The individual lender’s combined loan-to-value (CLTV) ratio limit

Say, for example, that your home’s current market value is $400,000. You still owe your original mortgage lender $110,000, so your total equity in the home is $290,000. To minimize risk, a HELOC lender might allow a combined LTV of up to 80%; this means that you could potentially borrow up to $210,000 with a HELOC against your property.

$400,000 market value x 80% CLTV limit = $320,000 maximum debt 

$320,000 CLTV limit - $110,000 existing mortgage = $210,000 possible HELOC

Because a HELOC is secured by your home’s equity, the bank can seize your asset (in this case, your home!) if you default on the debt.

A HELOC is secured by your property’s equity, so it can sometimes be easier to obtain than unsecured products (like personal loans). Depending on how much equity you have in your home, you might also be able to borrow more with a HELOC than with a personal loan product. 

Understanding Personal Loans

A personal loan is an unsecured debt that can be borrowed from a bank, credit union, or other financial institution. Personal loans don’t typically require any collateral, so you won’t need to offer up any specific assets to the bank to secure the loan. 

Because personal loans aren’t secured, they may have more stringent eligibility requirements. Lenders will usually expect you to meet certain credit score and income limits, for example, and may also limit how much you can borrow. 

A personal loan is taken out as one lump sum. If you need more money later, you’ll need to take out another, separate loan. As the borrower, you’ll then be required to make monthly installment payments toward that debt, based on how much you borrowed and the repayment term you chose. Personal loans can also have variable or fixed rates, depending on what you chose at disbursement.

HELOC vs Personal Loan: When to Choose Each

Both HELOCs and personal loans offer you access to the funds you may need, regardless of how you plan on spending that money. However, there are some important differences to note, which may help you choose between the two. 

• If you have a lot of home equity: In order to utilize a HELOC, you’ll need to have home equity that you can borrow against. If you have quite a bit of equity, though, this type of secured debt can give you access to substantial funds as you need them.

• If you have an excellent credit score: While both HELOCs and personal loans have eligibility requirements, you may need a higher credit score to qualify for a personal loan (since they are unsecured).  

• If you want a predictable monthly payment or interest rate: HELOCs typically come with variable interest rates, which can change over time. Personal loans, however, can come with fixed interest rates and set loan terms, enabling you to budget for the monthly payments and interest charges for the life of the loan.

• If you only need to borrow a lump sum: With a personal loan, you’ll simply borrow one lump sum at one time and pay it back over a defined period of time. HELOCs allow you the flexibility to borrow as-needed, but can be more complex and unpredictable as a result.

• If you prefer a line of credit you can borrow from at any time: On the flip side, a HELOC can offer greater flexibility if you aren’t sure how much you need or when you’ll need it. With this line of credit, you can borrow up to your limit throughout the entirety of the draw period, rather than locking you into a one-time lump sum. 

Bottom Line

Both HELOCs and personal loans can be valuable financial products whether you’re looking to borrow cash for a big purchase, want to pay off your existing debt, or just need a cash safety net. HELOCs are only offered to homeowners with equity in their property, while personal loans are available to anyone who meets the lender’s eligibility criteria. Depending on how much you need to borrow, your credit history, and how you plan to spend the money, consider the value of a personal loan versus a HELOC and how each can help you reach your goals.