HELOC vs. Personal Loan: Key Differences to Consider

Borrowing money comes with many options, and two common choices are a Home Equity Line of Credit (HELOC) and a personal loan. Each serves different financial needs, making it important to understand how they compare before deciding which is right for you.

While both provide access to funds, they differ in key areas such as interest rates, repayment terms, and borrowing limits. Understanding these differences can help you determine which option aligns best with your financial goals.

Collateral Requirements

A key difference between a HELOC and a personal loan is whether collateral is required. A HELOC is secured by the borrower’s home, meaning the lender places a lien on the property. This allows for larger borrowing limits and lower interest rates, but failure to repay could result in foreclosure. Lenders typically require homeowners to have at least 15-20% equity in their property before approving a HELOC.

Personal loans, in contrast, are usually unsecured, meaning no asset is required as collateral. Because lenders take on more risk, approval is based primarily on credit score, income, and debt-to-income ratio. Borrowers with strong credit—typically 670 or higher—have better chances of securing favorable terms. Those with lower scores may still qualify but could face higher interest rates or stricter repayment terms. Some lenders offer secured personal loans, which require collateral such as a savings account or vehicle, but these are less common.

Interest Rate Structures

The way interest is applied to a HELOC differs significantly from a personal loan, influencing both cost and predictability. HELOCs typically have variable interest rates, meaning the rate fluctuates based on an underlying benchmark, such as the prime rate. When interest rates rise, so do monthly payments, making budgeting less predictable. Some lenders offer fixed-rate conversion options, allowing borrowers to lock in a portion of their balance at a stable rate, but this feature isn’t always available.

Personal loans almost always have fixed interest rates. From the moment the loan is issued, borrowers know exactly how much they will pay each month, simplifying financial planning. Fixed rates shield borrowers from market fluctuations, ensuring that rising interest rates won’t increase their payments over time. However, because personal loans are unsecured, interest rates tend to be higher than those of HELOCs, particularly for those with lower credit scores.

Loan Amount Flexibility

The amount you can borrow with a HELOC or a personal loan varies widely based on lender policies and borrower qualifications. HELOCs generally provide access to larger sums since they are tied to home equity. Lenders typically allow borrowing up to 85% of a home’s appraised value minus any outstanding mortgage balance. For example, if a home is worth $400,000 and the remaining mortgage is $250,000, a lender may approve a HELOC with a maximum limit of $90,000. This structure enables homeowners to tap into significant funds as needed, making it appealing for ongoing expenses like home renovations or business investments.

Personal loans have more rigid borrowing limits, typically ranging from $1,000 to $100,000, depending on the lender and the applicant’s financial profile. Unlike a HELOC, where the loan amount is determined by property value, personal loan limits are based on credit history, income, and debt obligations. High-income borrowers with excellent credit may qualify for upper-tier amounts, while those with lower credit scores or higher existing debt may face restrictions. Additionally, some lenders cap unsecured loan amounts, making it difficult to obtain large sums without collateral.

Repayment Schedules

The repayment structure of a HELOC differs significantly from a personal loan, affecting both short-term affordability and long-term financial planning. A HELOC typically has two phases: the draw period and the repayment period. During the draw phase, which often lasts 10 years, borrowers can access funds as needed and are usually only required to make interest payments. This provides flexibility but can lead to a payment shock once the repayment phase begins, as the borrower must start repaying both principal and interest, often over a 10- to 20-year term.

Personal loans follow a fully amortizing repayment structure, meaning each payment includes both principal and interest from the outset. Loan terms typically range from 12 months to seven years, with fixed monthly payments that remain unchanged throughout the loan’s duration. This predictability allows borrowers to plan their budgets more effectively, as there are no surprises in future payments. However, the fixed structure means there is no flexibility to borrow more once the loan is disbursed, unlike the revolving nature of a HELOC.

Tax Aspects

The tax treatment of a HELOC and a personal loan differs, which can influence the overall cost of borrowing. HELOC interest may be tax-deductible, but only if the borrowed funds are used for home improvements that qualify under IRS guidelines. For example, using a HELOC to remodel a kitchen or add an extension could allow borrowers to deduct interest payments, whereas using the funds for personal expenses, such as debt consolidation or travel, would not qualify. The Tax Cuts and Jobs Act of 2017 limited this deduction, so homeowners should consult a tax professional to ensure compliance with current regulations.

Personal loan interest is generally not tax-deductible. Since these loans are typically unsecured and used for a variety of purposes, the IRS does not allow deductions on interest payments. There are a few exceptions, such as when a personal loan is used for qualified business expenses or certain educational costs, but these cases are less common. Borrowers considering tax implications should weigh whether a HELOC’s potential deduction benefits outweigh the risks associated with using home equity as collateral.

Credit Criteria

Lenders evaluate creditworthiness differently for HELOCs and personal loans, influencing approval odds and borrowing terms. HELOC approval depends on both credit history and home equity, with lenders typically requiring a minimum credit score of 620, though scores above 700 often secure better rates. Debt-to-income (DTI) ratio also plays a role, with most lenders preferring a DTI below 43%. Additionally, lenders assess loan-to-value (LTV) ratio, ensuring homeowners have sufficient equity to support the credit line.

Personal loans rely more heavily on credit scores and income, as they lack collateral. Borrowers with scores above 670 generally qualify for competitive rates, while those with lower scores may face higher interest or require a co-signer. Lenders also evaluate income stability and existing debt obligations, ensuring borrowers can manage fixed monthly payments. Since personal loans are riskier for lenders, approval criteria tend to be stricter, particularly for larger loan amounts.