Home equity loans are often referred to as second mortgages and are usually secured in nature. When you talk of a personal loan, you usually mean an unsecured loan that is not tied to any collateral.
The differences between a home equity loan and a personal loan or line are usually those found between a secured loan and an unsecured loan.
Comparing the Two
Both can take any of the two forms – a term loan or a line of credit. Here are some quick differences.
| Term Loan | Line of Credit | |
| Funding | one-time lump sum | Revolving credit |
| Interest Rate | Fixed | Adjustable |
| Repayment | Fixed payments every month over a fixed term | Payments vary every month over a period of fixed term |
When is a HELOC better than a home equity loan?
Home equity loan vs. secured personal loan
The two are almost the same as a borrower must put up some collateral for approval. You know what your collateral is when you are applying for a home equity loan. For the secured personal loan, the collateral can be anything that your lender wishes.
The advantages with the former usually include higher borrowing limit, lower interest rate and longer repayment term. A secured personal loan can be a good alternative when you don’t own a house, but have some other thing of value to borrow against.
Home equity loan vs. unsecured personal loan
When you talk about the differences between a home equity loan and a personal loan, the latter usually means an unsecured one. As a result, the differences between the two are typically those found between a secured and unsecured loan.
Probably the biggest advantage with an unsecured loan is that you don’t have anything to lose in case of a default. As this makes the loan riskier for a lender, it is not as easy to obtain. You need a very good credit score for approval and will still pay a much higher interest rate.
HELOC vs. personal line of credit
These work more like a credit card. You take out as much money as you need subject to the credit limit and pay back to make the deposit available for use again.
A HELOC offers a lower interest rate than that of a personal line of credit, but it requires collateral and can only be possible if you have some equity.
You need to have a very good credit score to qualify for a personal line of credit. On the other hand, your equity in the home that you own will act as a determining factor for the upper limit of your HELOC.
How to Choose between a Home Equity Loan and a Personal Loan?
The following few paragraphs will help you choose the best financing option.
Determine the purpose
A loan must be repaid. So, first you need to ensure if you really need a financial assistance. What is the purpose, if you put it simply?
A term loan suits the best when you need to pay in one lump-sum, such as to pay for a vacation or make a new purchase. A personal loan can be used for businesses also.
Specialized personal loans exist to buy things, such as a car, boat or a recreational vehicle. Experts advise against the use of a credit card for vacation because of high interest rates.
A line of credit, whether HELOC or personal line of credit, seems a more suitable idea if you need to pay in small amounts recurrently over a period of time, such as for education or home improvement.
A student loan, on the other hand, is designed specifically to help students pay for their tuition fees and meet other cost of education. Some lenders offer home improvement loans also.
Additionally, a personal line of credit can be tied to a checking account to avail overdraft protection.
Check your eligibility
The whole idea of comparison and selection makes sense only when you are eligible for both. So, the first thing to do would obviously be to check your eligibility.
While a higher credit score can guarantee quick approval and a lower interest rate on a personal signature loan, the value of equity in your home will help determine the amount you can borrow against a home equity loan.
See if you can wait
Sometimes, you need money immediately and are not in a position to face a complicated underwriting process as is the case with a home equity loan or line. A personal loan will be an obvious option in this case.
Consider a medical emergency. You don’t have enough time to wait for a longer approval process to end. A personal loan can typically be approved in two hours and you will have the necessary fund within a day or two.
Evaluate the cost
A home equity loan can be a cheaper option than a personal loan. Obviously, the former would be your first priority. However, it is not easier to obtain a home equity loan under certain circumstances.
A personal loan may prove too costly if you do not possess adequate credit score. For purposes, such as debt consolidation, you need to weigh all your options carefully to come up with the best one.
A cash-out refinance often comes as an excellent alternative for homeowners to consolidate their debts.
Estimate the amount you need to borrow
Not many personal loan lenders would allow you to borrow more than $25,000. Contrarily, a home equity lender is usually not interested in lending small amount.
You get the point. Seek a personal loan if you need only a few thousand dollars. To borrow close to a hundred thousand dollars, try a home equity loan instead.
Ensure if you are comfortable with the repayment schedule
A personal loan is easy to repay as the monthly payment as well as the term of loan is fixed. Such loans usually come with a fixed interest rate.
On the other hand, a home equity loan can be repaid in 5 to 15, and even 30 years. Though your monthly payment would be smaller, you will remain in debt for a longer period.