A personal loan or home equity credit may be an option if you have larger financial goals such as debt consolidation or home improvement.
Both can be great borrowing options. However, it is important to know the differences between them so you can choose the best option for your financial situation.
A home equity loan, also known as a HELOC, is secured by your house. Personal loans are usually unsecured and are based on your credit score and income.
This article will help you make a decision.
What is the difference between a HELOC or a personal loan?
What is the main difference between a HELOC loan and a personal loan? How they are usually secured. This will affect your loan terms.
A HELOC is a credit line that uses your home equity to secure the loan. Personal loans are typically unsecured loans that don’t have collateral backing them.
Your possessions won’t be at immediate risk if your personal loan is defaulted on. However, in some cases, the personal loan lender may sue you for not paying debt. This could put your assets at risk. To pay the unpaid debt, your wages could be garnished and a lien placed on your house.
Unsecured personal loans typically have higher interest rates than secured debt. However, that is not the only difference between HELOCs and personal loans. Let’s look at how these loans differ from each other.
|
HELOC |
Personal loan |
|
|---|---|---|
|
Interest Rate |
Variable | Usually fixed |
|
Collateral |
Your home | If unsecured, none |
|
Max. Maximum loan amount |
Maximum $1 Million | As high as $100,000 |
|
Repayment options |
Principal + interest, or Interest-only | Fixed amounts (equal installments). |
|
Potential fees |
Closing + origination fees, prepayment penalties and draw fees, as well as annual membership fees | Late fees and origination fees |
|
Tax benefits |
For certain years and uses, interest may be exempt from tax | None |
Interest rates
HELOCs usually have lower interest rates than personal loan, but they are often more flexible and can change over time. HELOCs are revolving credit lines, which means that you will only pay interest on the outstanding balance.
If you have $50,000 in credit, but only $4,000 of it, then you will only owe interest and payments on $4,000.
Unsecured personal loans are not secured and don’t require collateral or security. They also have fixed interest rates, payment amounts, and no collateral. You can borrow a lump sum upfront, and the terms will remain the same throughout the loan’s life.
Qualifications
As with any loan, you will need to meet the requirements of the lender for HELOCs or personal loans.
A HELOC requires that you meet the financial requirements of the lender and have a property you can borrow against. A minimum of 85% of the home’s value (less any mortgage owing) is required.
If your home is valued at $400,000 and your mortgage balance is $250,000, then the maximum amount you can borrow would be $90,000.
Collateral
Personal loans are typically unsecured and do not require collateral. Because the lender views personal loans as a higher risk, their interest rates are usually higher than those with HELOCs.
However, a HELOC is secured by your house, so defaulting could lead to your home being foreclosed.
Loan amounts
Lenders can offer personal loans from $1,000 to $100,000. However, many lenders reduce their maximum loan amounts to closer to $50,000. A higher credit score, better income, and a more favorable financial profile will increase your chances of getting a loan at competitive rates.
HELOCs are linked to your home’s equity so the loan amounts can be higher than personal loans. HELOCs can be offered by some lenders up to several hundred thousands dollars, and in some cases up to one million.
You can finance home improvements using a personal loan but you might not be eligible for the same amount as with a secured debt such as a HELOC.
Terms of repayment
Personal loans have very simple repayment terms. A fixed payment will usually be required to cover the principal and interest. These terms will remain the same throughout the loan term (the length of the loan).
You may have different options for repaying your HELOC. You can make payments to cover principal and interest.
An interest-only payment is another option, but it will not pay down the principal of your loan. Consider that your monthly payment could increase significantly if this option is chosen.
You may be able to convert your repayment plan into a fixed-term installment loan from some lenders.
Fees
Personal loans and HELOCs often have fees. Personal loans and HELOCs can come with fees. These fees are sometimes waived by some personal loan lenders, but it is important to be aware of the lender fees in order to know what your loan costs.
HELOCs may be subject to closing costs or other fees. These could include any of the following:
- Appraisal fee
- Application
- Points
- Attorney fees
- Search fees for titles
- Document fees
- Taxes
- Annual fee/Account Maintenance Fee
Lenders may waive some or all of the fees associated with a HELOC.
Tax incentives
For qualified purposes, the interest paid on a HELOC might be tax-deductible. However, it is not for personal loans.
You must remember that you cannot deduct the tax from interest paid on a HELOC. The money will need to be used to improve your home.
It’s a smart idea to speak with a tax professional to learn more about your specific situation.
Credit risk for default
Your credit score can be affected if you default on a personal loans. Your assets will not be at immediate risk.
A HELOC is different. If you default on your loan, the lender could have the right of foreclosing on your home. This activity could also be reported to credit bureaus and appear in your credit reports.
Are personal loans better than HELOCs?
Both personal loans and HELOCs have their pros and cons. It all depends on how much money you need and what purpose you are borrowing.
These are some times you might want to consider a personal loan, or a HELOC.
Personal loan
- Consolidating high-interest debt
- A cosmetic procedure such as braces or tattoo removal is covered
- Wedding costs
HELOC
- Tuition and fees for college
- Ongoing home improvement projects
- Consolidate your debt
For smaller expenses that you won’t be facing often, a personal loan is the best option. HELOCs are best for continuing expenses. They allow you to repay the credit line over a longer period of time and can be used again.
What’s next?
It doesn’t matter what you do, it is smart to compare offers from different lenders before you make a decision. Compare rates and terms to find the best deal. Consider both the monthly and total interest costs.
Before you sign on the dotted sheet, you need to understand the risks and benefits of a personal loan or HELOC.