HELOC vs personal loan

When you need to finance a large expense, a home equity line of credit (HELOC) or personal loan can help you get the cash you need. With a HELOC, you can periodically borrow against your home's equity. Personal loans, on the other hand, do not require collateral. You will receive a lump sum amount and then repay it with fixed monthly payments.

These flexible loans can be used for many different needs, including home renovations, medical bills, consolidating high-interest debt or to pay for a wedding or large purchase. It's important to understand the HELOC vs personal loan differences before you apply so you can choose the best option for your needs.

What is a HELOC?

A HELOC is a revolving line of credit that is backed by the equity in your home. You can borrow funds as needed up to your credit limit during the draw period, which may be up to 10 years. Your available credit is replenished when you repay the money you borrow. After the draw period ends, you transition into the repayment phase where you make fixed monthly payments to repay the principal and interest.

Many people choose HELOCs because of their flexibility. They are ideal for when you need to periodically borrow money, like during a bathroom renovation project. For example, you could borrow money for new flooring and then later borrow more for new cabinetry. When you're ready, you can access additional funds for a new bathtub and sink.

A HELOC can help you save money. It typically offers a lower interest rate than credit cards or personal loans, and you also have the option of making interest-only payments during the draw period, which helps you keep your project costs in check. Additionally, you only have to pay interest on what you borrow.

Before you choose a HELOC, it's important to understand the potential drawbacks. Because your home serves as collateral, you could face foreclosure if you are unable to make the payments. HELOCs also have variable interest rates, which means your payments could rise over time. If you have a HELOC and you decide to sell your home, you will also have to pay off the loan at the closing.

What is a personal loan?

Collateral isn't needed for a personal loan. You'll receive a lump-sum amount and repay it with fixed monthly payments, which means you don't have to worry about future rate increases. Personal loans typically have terms of two to seven years.

Personal loans can be used for many different needs, like consolidating high-interest credit card debt. Combining your balances into a single loan with a lower rate simplifies your finances and reduces your costs. Instead of managing multiple due dates, you'll have one payment to keep up with each month. Personal loans are ideal for situations where you know the total costs upfront and you prefer the stability of fixed monthly payments.

Because personal loans don't require collateral, they're accessible to borrowers who don't have much equity in their homes or renters. The loan approval process usually only takes a few days, and you also don't have to worry about losing your home if you miss payments.

Personal loans have some downsides to consider, however. Because they're unsecured loans, they usually have higher interest rates than secured loans. Also, the loan amounts are often lower than with secured loans. Receiving a lump-sum amount upfront also means you'll have to apply for a new loan if you run into unexpected expenses later.

HELOC vs personal loan: Which is better?

A HELOC is a good option when you have substantial equity in your home and you need a flexible way to access funds over time. It's especially useful when costs are uncertain or are likely to change, like during a home renovation when you make changes to your plans. The initial interest-only payments can also be beneficial if you need to keep your costs low while you are completing a project.

If you don't have sufficient equity or you don't want to use your home as collateral, another loan may be a better choice. Since a HELOC has a variable interest rate, you may also face future rate increases. If you are planning on selling your home in the near future, you will also have to pay off your HELOC as part of the sale.

A personal loan may be a better fit when you know how much you need and you want to borrow the full amount upfront. You can lock in your interest rate and enjoy fixed monthly payments until the loan is repaid. Also, because no collateral is required, you aren't at risk of losing your home if you are unable to make the payments.

Personal loans aren't ideal for all situations, however. Since they are not secured with collateral, they often have higher interest rates than HELOCs, which increases the cost of borrowing. And because you receive the full amount upfront, they also aren't as flexible if you aren't sure how much you'll need or if you think your expenses will change over time.

As you consider a HELOC vs personal loan, ask yourself:

• How much equity do I have in my home?
• Do I know exactly how much I need to borrow?
• Do I need to borrow the full amount upfront?
• Am I comfortable using my home as collateral?
• Do I need predictable monthly payments?

Other forms of financing to consider

HELOCs and personal loans aren't the only choices available. Depending on your needs, another form of financing may be better

Credit cards: Credit cards are ideal for small purchases or emergencies. Although they have higher interest rates, they can be used for things that you can quickly repay, like a minor car repair.

Home equity loans: You receive a lump sum and repay it with fixed monthly payments. The loan is backed by the equity in your home, and you'll get a lower interest rate than with a personal loan. A home equity loan might be a good option when you know your costs upfront and you want a lower interest rate than a personal loan.

Personal line of credit: This financing option works like a HELOC, but your home isn't used as collateral. Also, because it's unsecured, it typically has a higher interest rate than a HELOC. A personal line of credit may be a good option when you don't have much equity in your home and you need a way to periodically access funds.

Cash-out refinance: You replace your existing mortgage with a new mortgage for more than you owe and receive the difference in cash. A cash-out refinance might be a good choice when interest rates drop and you want to lower your mortgage rate and borrow cash at the same time.

Choosing the right loan

HELOCs and personal loans are both good options for financing large expenses. HELOCs are backed by the equity in your home and offer flexible access to funds at lower rates. Personal loans offer predictable payments without collateral but typically have higher interest rates.

If you're unsure of which loan is best for your needs, contact a lending expert at Citizens to discuss your options. A HELOC could be a flexible, affordable solution that helps you achieve your goals.

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