Home Equity Loans, HELOCs, and Personal Loans: What’s the Difference?

Personal loans, home equity loans, and home equity lines of credit (HELOC) are popular options when it comes to financing major expenses. Each provide necessary funds to advance your financial goals, but before deciding on one, review this article to better understand the features, benefits, and uses of each so you can choose an option that best fits your specific needs.

First, let’s define each loan type:

• Unsecured personal loan: A personal loan can be a secured (backed by collateral) or unsecured loan that individuals can use for various purposes. Unlike home equity loans and HELOCs, unsecured personal loans don’t require collateral. The loan amount and interest rate are based on factors such as credit history, income, and debt-to-income ratio.
• Home equity loan: With a home equity loan, homeowners secure the loan by using their home as collateral. The loan amount is determined by the homeowner’s equity, which is the appraised value of the home minus the remaining mortgage balance.
• HELOC: A HELOC is a revolving line of credit that homeowners can access as needed. Like a credit card, homeowners can borrow against their home’s equity up to a predetermined limit during a specified draw period.

Now that we have a basic understanding of each loan type, let’s explore the differences in detail.

Optimal use and considerations

Each loan type has its optimal use and considerations. Here’s a breakdown:

• Unsecured personal loans are used for various purposes, including major and minor purchases. They are a viable option for individuals who may not have, or who prefer not to use their property as collateral.
• Home equity loans are well-suited for major purchases, such as home improvements or debt consolidation. Homeowners can leverage the value of their home and benefit from potential tax deductions with these loans.
• HELOCs allow borrowers access to funds as needed during the draw period. They’re ideal for ongoing or regular expenses, such as college tuition payments, medical expenses, or recurring home improvements.

Loan amount and collateral

Another significant difference between these loan types is the loan amount and collateral requirements. Here’s what you need to know:

• Unsecured personal loans: While these loans do not require collateral, approved loan amounts can vary depending on factors such as credit history, income, and debt-to-income ratio. Lenders evaluate these factors to determine the borrower’s creditworthiness and the loan amount they can offer.
• Home equity loans: The loan amount for a home equity loan depends on various factors, including the homeowner’s equity. Homeowners can borrow a portion of their home’s appraised value minus the remaining mortgage balance. Collateral for home equity loans is the property itself, making it a secured loan.
• HELOCs: Similar to home equity loans, the loan amount for a HELOC is based on the homeowner’s equity. Homeowners can access funds up to a predetermined limit during the draw period. The property serves as collateral for the HELOC.

While home equity loans and HELOCs are directly linked to the home’s equity, unsecured personal loans provide more flexibility in terms of the loan amount and don’t require collateral.

Loan payment

The method of loan payment also sets these loan types apart. The payment structure of these loans determines how borrowers can access funds and make repayments, providing different levels of flexibility and control over the loan amount. Let’s take a closer look:

• Unsecured personal loans are disbursed in a lump sum. After signing the loan agreement, borrowers receive the entire loan amount, which they can use as per their needs.
• Home equity loans also give borrowers the entire agreed-upon loan amount in a lump sum after signing the contract. Funds are then transferred to the borrower’s account, allowing them to use the funds as needed.
• HELOCs are revolving loans much like a credit card. Once the servicing agreement has been signed, the draw period begins. Borrowers can withdraw money from the line of credit as needed and use the funds incrementally based on their financial requirements.

Interest rates and repayment terms

Interest rates and repayment terms are essential factors to consider when choosing a loan. Each of these loans is a bit different in these areas.

• Unsecured personal loans also offer fixed interest rates, providing borrowers with a predictable repayment plan. The repayment terms for these loans usually range from 1 to 10 years, allowing borrowers to choose a term that suits their financial situation.
• Home equity loans typically offer fixed interest rates, meaning the interest rate remains the same throughout the loan term. Repayment terms for home equity loans can range from 5 to 30 years, allowing borrowers to choose a term that aligns with their financial goals.
• HELOCs often come with variable interest rates, which means it can change over time. HELOCs have 2 phases known as the draw period and the repayment period. The draw is typically 5 to 10 years. At this time, borrowers can use the money and are only required to repay interest. In the repayment period—usually 10 to 20 years—borrowers are required to pay both principal and interest.

It’s important to note that the interest rates for unsecured personal loans are generally higher than home equity loans but slightly lower than HELOCs.

Annual percentage rate (APR)

The annual percentage rate (APR) is a major factor to consider when comparing loan options. Here’s how the APR differs for unsecured personal loans, home equity loans, and HELOCs:

• Unsecured personal loans typically have higher interest rates compared to home equity loans and HELOCs. The APR for unsecured personal loans can vary based on the borrower’s credit history, income, and other factors. Some loan providers offer loans with no fees, while others may charge origination fees or other charges.
• Home equity loans can have different APRs depending on the lender and the borrower’s creditworthiness. While fees and other charges may differ, home equity loans generally offer lower interest rates compared to unsecured personal loans.
• HELOCs, like home equity loans, have APRs that can vary depending on the lender and the borrower’s creditworthiness. The interest rates for HELOCs are often slightly higher than home equity loans but lower than unsecured personal loans.

Comparing the APR for these loan options is crucial in understanding the overall cost of borrowing and selecting the most affordable option for your financial needs.

Tax benefits

Tax benefits can play a significant role in the decision-making process when considering home equity loans, HELOCs, and unsecured personal loans. While unsecured loans don’t typically offer tax benefits, interest on home equity loans and HELOCs may be tax deductible if used for approved home improvement projects. Consult with a tax professional to determine your specific tax implications.

Conclusion

Home equity loans, HELOCs, and unsecured personal loans provide individuals with different financing options for various financial needs. Understanding the differences in interest rates, repayment terms, loan amount, collateral requirements, loan payment methods, APR, and tax benefits is crucial in making an informed decision.

Consider your specific financial goals and circumstances when selecting a loan type. Whether you need funds for home improvements, debt consolidation, or other major expenses, carefully evaluate each loan option’s features and benefits to choose the best fit for your needs.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.