HELOC vs. Personal Loan: What’s the Difference?

By MoneyTips Writer / Reviewed by Published Apr. 29, 2022 Read time 9 min

A HELOC gives you a revolving line of credit, while a loan provides a lump sum of cash
HELOCs use your home as collateral, and they come with lower interest rates and interest-only payments for the first 10 – 15 years
Personal loans don't require collateral, but they have lower borrowing limits, potentially higher interest rates and shorter repayment periods

When you have a big project in mind – like installing a pool in your backyard or paying off a bunch of high-interest credit cards – you’ll need access to cash.

That’s where a home equity line of credit (HELOC) and a personal loan can come in. Both options can provide access to the money you need, but which is better: a HELOC or a personal loan?

A HELOC has a higher borrowing limit and lower interest rates, and your home serves as collateral.
A personal loan has higher interest rates, but the approval process is faster, and you won’t need to put your home up as collateral.

Before you determine which option is right for you, we’re going to tell you everything you need to know about HELOCs and personal loans so you can make the best decision based on your financial goals.

What Is a HELOC Loan?

A home equity line of credit (HELOC) is a loan that gives you access to a revolving line of credit. A HELOC is a secured loan, which means you’ll need to provide an asset to back up the loan. In the case of a HELOC, your home equity serves as the collateral for the loan.

If you already have a mortgage on your home, a HELOC can be a second mortgage. If you own the home outright, the HELOC becomes the primary mortgage.

Think of a HELOC as a credit card. You can borrow money up to your credit limit, pay it off and repeat the process. One major difference between HELOCs and credit cards is that the interest rates on HELOCs are usually lower than they are on credit cards.

Every HELOC has a draw period that’s usually open for 10 – 15 years. You can use the line of credit by withdrawing money during the draw period.

Here’s a great thing about the draw period: You only pay interest on the money you borrow.

At the end of the draw period, you start paying back the total loan amount. These payments are usually spread out over 20 years (aka the repayment period).

Banks will usually qualify you for a HELOC as long as you have more than 15% – 20% in home equity (the difference between what you owe on your home and its appraised value).

If your home is worth $200,000 and you owe $100,000, you have 50% equity. Your lender will require that you keep at least 15% of the $200,000 value of your home in reserve, so you’d only be able to borrow against up to $170,000. That means you can borrow up to $70,000 with a HELOC.

So what can you do with that money? Let’s look at some common uses:

Repair or renovate your home
Pay off high-interest debts
Cover a health or financial emergency

Most homeowners use HELOCs for home improvements. You can add a pool, build an addition or get rid of that 1960s paneling in the family room.

If you’ve ever done a renovation project, you know it can be full of surprises. That’s why a HELOC is so convenient – you’re not locked into a specific amount. You can borrow as much (or as little) as you need, up to the credit limit.

A HELOC also creates a financial buffer in case of an emergency. If your pipes burst in the winter or you need surgery, you can access the funds without having to worry about paying it back immediately.

Is a HELOC as good as cash? Not quite. You pay interest on the money, after all. But, it’s a close second. Your bank will give you a credit card or checkbook so you can access the funds whenever you want.

What Are the Pros and Cons of a HELOC?

A HELOC typically has a high credit limit and allows you to pay the loan off over a longer period of time, typically spread out across 20 years.

Honestly, what’s not to like? However, it’s still a loan. A loan that will affect your finances for the next 30 – 35 years when considering the draw period.

Before you rush out to apply for a HELOC, consider the pros and cons.

✅You can borrow a large amount of money at low interest rates.

✅It’s easy to access the money.

✅You only pay interest on the money you borrow.

✅Payments are affordable during the draw period.

✅You could have up to 20 years to repay the loan.

✅The interest you pay may qualify for a mortgage interest tax deduction.

⛔The approval process can take up to 45 days.

⛔You’ll need to pay closing costs, title search fees, an appraisal fee and other lender fees. You may also need to pay an annual fee.

⛔Payments increase after the draw period.

⛔Your lender may offer variable rather than fixed interest rates. That means your interest rate can increase or decrease over time.

⛔If you can’t make your payments and default on the loan, you risk losing your home.

What Is a Personal Loan?

A personal loan is money you borrow at a fixed interest rate and repay with fixed monthly payments. Banks don’t usually require collateral for personal loans, and you’ll have less time to pay a personal loan back, usually 2 – 7 years.

Personal loans generally tend to have higher interest rates than HELOCs. The interest rate you pay usually depends on your creditworthiness.

With a good credit score, a low debt-to-income (DTI) ratio and a steady income, you could get an interest rate of 5% – 10%. If your credit score is at the lower end of the spectrum, you may be offered 15% interest rates or higher.

Lenders may offer personal loans up to $50,000, but the amount you qualify for will depend on your finances.

You can use a personal loan for whatever you like. Borrowers mostly use personal loans for:

Vacations and special events
Auto repairs
Medical bills not covered by insurance
Unexpected or emergency expenses
Small-scale home renovation projects

When you take out a personal loan, you pay interest on the entire amount. And unlike a HELOC, you start making full payments (interest + principal) right away.

What Are the Pros and Cons of Personal Loans?

When you need money, a personal loan can be a fast, easy solution. However, it’s not the best option for every scenario.

Figure out if personal loans work for your finances and future goals by taking a look at their pros and cons.

✅Lenders usually approve your application and disburse the money within a week.

✅The interest rate is usually fixed for the life of the loan. That means fixed monthly payments.

✅With good credit, you can get low interest rates, especially when compared to credit card rates.

✅You don’t need to put your home up as collateral.

⛔The borrowing limits are lower.

⛔Banks may charge a processing fee.

⛔The loan’s interest isn’t tax deductible.

⛔Your credit score affects your interest rates and loan amount.

⛔The repayment terms are short.

⛔Full payment starts immediately.

Which Is Better: A HELOC or a Personal Loan?

You can probably guess what we’re going to say, so we’ll keep it short: There is no right answer.

The better question to ask is which loan is better for your situation.

If you have a good amount of equity in your home, HELOCs offer serious perks like high borrowing limits and low interest rates. They can be a good option if you need lots of money for a big upgrade.

Are you thinking of selling your home in a few years? A HELOC might not be the best choice. When you sell, you’ll have to pay off your existing mortgage and your HELOC (aka second mortgage).

One of the biggest risks associated with a HELOC is losing your home if you default on the loan. Think long and hard on this one. If you’re not confident about your ability to afford the higher payments at the end draw period, a personal loan might be the better choice.

Personal loans are also a great option when you need to borrow a relatively small amount of cash. And if you need money quickly, personal loans have the advantage. It usually takes less than a week to apply and get the funds. You may need to pay a processing fee, but you’ll avoid the expensive closing costs associated with HELOCs.

Best uses for HELOCs

You can use a HELOC for anything, but you’ll get the most bang for your buck with:

Home improvements: Smart upgrades, such as a kitchen update or landscaping, can increase the property’s value and build more equity.
Real estate investments: If your finances are stable, a HELOC can help you get started in real estate investing. You can use the funds to buy another property or make a down payment on a second property. You can pay off the HELOC with the rental income you make.

In both cases, you may be able to deduct the interest on the HELOC and reduce your taxable income.

Best uses for personal loans

There are times when the speed and convenience of a personal loan make it a better option for:

Unexpected expenses: Sometimes life hits you with surprise expenses. Your car breaks down, or you break a tooth and need to pay for a root canal. You don’t have the luxury of time in these situations. And that’s when a personal loan can make sense. You can use the funds to cover urgent needs.
Debt consolidation: Credit cards and private student loans can drown you in high interest rates. If you’re making payments on a variety of loans and credit each month, using a personal loan to consolidate your debt may be the right solution. You can pay off your debts with a lower-interest debt consolidation loan. Once you’ve consolidated your loans, you’ll only have a single payment to make, and you’ll, hopefully, pay less in interest.
Borrow without equity: Maybe you recently bought a home and you want to make upgrades, but you don’t have enough equity to qualify for a HELOC. Instead of waiting, you could get a personal loan to pay for the renovations. Just make sure you can afford your mortgage and the loan payments.

What Are Some Alternatives to HELOCs and Personal Loans?

Do the risks outweigh the benefits of HELOCs and personal loans? There are other ways to get the cash you need.

Home equity loans

Home equity loans also use your home’s equity as collateral, but instead of receiving a line of credit, you get a lump sum of cash. You pay interest on the total home equity loan amount. And the payments, which are fixed, start right away.

If you’re deciding between a home equity loan or a personal loan, just know that a home equity loan takes longer to get, but the interest rates may be lower.

The main difference between a home equity loan and a personal loan is that a home equity loan uses your home as collateral and a personal loan is typically unsecured and requires no collateral.

When you’re deciding between a secured personal loan (which requires collateral) and a home equity loan, consider their respective interest rates and the value of the collateral.

Cash-out refinancing

Have interest rates dropped since you bought your house? Have you built up a decent amount of home equity?

You may want to consider a cash-out mortgage refinance. You take out a new mortgage for more than you currently owe on your home – ideally at a lower interest rate. You pay off the existing mortgage and any money left over is yours to keep.

With a cash-out refinance, you get the funds you need without adding an extra payment on top of your original mortgage payment. The extra amount borrowed (read: the cash in your hand) is rolled into your normal mortgage payment. Also, the mortgage interest rates for cash-out refinances tend to be lower than the rates on HELOCs.

Credit cards

If you don’t need to borrow a lot of money, a credit card might be a better option than a HELOC. With a credit card, you can borrow what you need without having to put your home on the line.

Before you charge anything on a high-limit credit card, make sure to check the interest rate. If you’re planning on applying for a new credit card, shop around for the best rates.

A personal line of credit

A personal line of credit works like a HELOC, but it doesn’t require collateral. The interest rates on personal lines of credit are typically higher than the interest rates on HELOCs but lower than the rates on credit cards and personal loans.

The draw period for a personal line of credit is short, so it works best for short-term projects. If you’re not ready to start the repayment period, your bank may allow you to refinance to extend the draw period.

It’s More Than a Feeling. Trust Us, You’ll Know

When you want to make home improvements or cover surprise expenses, HELOCs and personal loans are two popular options. Both can get you the cash you need. You just need to know the pros and cons of each so you can make a choice that’s in line with your finances.

No matter which loan you choose, it’s important to be vigilant about your finances in general. The better financial position you’re in, the likelier it is that you’ll qualify for lower interest rates and a higher borrowing limit.