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Personal loan or a HELOC: Which is right for me?

Peter Warden
The Mortgage Reports editor

The smarter choice: a personal loan or a HELOC?

Should you choose a personal loan or a HELOC? You’ve already guessed the answer: It depends. But on what?

The main things are your personal circumstances: whether you’re a homeowner, how good your credit is and whether you can afford the payments.

But what you spend the money on can also be decisive. Because you may get some tax relief if you use a HELOC to pay for home improvements. But there’s no such break with personal loans. Of course, you can spend the money from either on anything you want.

But what are HELOCs? How do they work? And how are they different from personal loans? Read on to find out.

Check my eligibility for a personal loan up to $100k * (Sep 16th, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

What is a HELOC?

HELOC is an acronym that stands for home equity line of credit. And your home equity is the amount by which the current market value of your home exceeds your mortgage balance. With a HELOC, you use some of that equity as security for your borrowing.

All this means that HELOCs are available only to homeowners. If you currently aren’t one, you can skip the rest of this article and instead read up on personal loans.

Everything you need to know about personal loans

How HELOCs work

Still here? We’ll assume you’re a homeowner with a reasonable amount of equity. In that case, you can choose between a personal loan or a HELOC.

HELOCs are like the love children of a home-equity loan and a credit card. Like with a home-equity loan:

  • They typically come with low interest rates
  • Your home is security (or collateral) so you could face foreclosure if you default
  • You can borrow over a long period: often 10 years. With many HELOCs, you get another five years after that to pay down your balance. Check your offer to see the deal you’re getting

Like with a credit card, you:

  • Can borrow up to your credit limit
  • Can repay and reborrow up to that limit anytime you want
  • Pay interest only on your current balance

HELOC warning

One of those bullet points referred to your borrowing for 10 years (the “draw period”) and repaying over five (the “repayment period”). While not all HELOCs are the same (they can last up to 20 years), that scenario is quite common.

And it can pose a problem for some borrowers. After a decade of being able to borrow and paying only interest on your balance, you’re suddenly faced with being unable to borrow and having to pay down your loan plus interest. That comes as a shock to some.

If you want to borrow a lump sum using your equity and pay it back in equal installments, you should check out home equity loans.

Home equity loan vs line of credit (HELOC)

Personal loan or a HELOC: some differences

Both types of loan typically come with variable interest rates. However, there are often fixed-rate options. Here are some other similarities and differences:

Interest rates

Perhaps surprisingly, it’s sometimes possible to pay a lower rate on an unsecured personal loan than a secured HELOC. That’s because lenders focus on your credit history when setting a rate for a personal loan but on your equity when doing the same for a HELOC.

That may be why one online source reckoned at the time of writing that the national average rate for HELOCs was 6.73%, while it’s easy to find personal loans advertised at less than 6%.

Bear in mind how quickly those personal loan rates rise for those with less than good credit. Even with mainstream lenders, they often top out at close to 36% for those with fair or bad credit. And some won’t get approved at all.

Across all credit score ranges, HELOCs probably come out with a lower average rate. But borrowing for a longer period can mean you pay more in total, even if your rate’s lower.

Remember, too, those tax breaks on HELOCs. They can bring down your total cost of borrowing — but only if you spend the proceeds on home improvement costs. And always speak to a professional adviser before making a decision based on the expectation of a tax break.

Terms

Most personal loans last up to five years, though you can sometimes find them with longer terms. However, most HELOCs last 15 or 20 years, including both draw and repayment periods.

Getting your money

With a personal loan, you get a lump sum to do with what you will. But with a HELOC, you draw down funds as you need them, up to your credit limit.

Setup costs and headaches

Here’s where personal loans are the clear winner.

A HELOC is a second mortgage and typically comes with origination costs and administrative demands that can be close to those for a first mortgage. Even when lenders say they’ll waive costs, those are usually just recouped through a higher interest rate. As importantly, a HELOC can take several weeks to get from an application to the funds being available.

By contrast, personal loans are cheap (sometimes free) and easy to set up. And you usually get the money within a week, often on the next business day and sometimes on the same business day that you make the application. Very large loans may take a bit longer and require more paperwork.

So should you choose a personal loan or a HELOC?

And so we return to our original question. And the answer’s still the same: It depends.

But at least you now know how to make a smart decision.

Check my rate for a personal loan up to $100k * (Sep 16th, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV