HELOC vs. personal loan: How to choose the better one for you

Do you want to consolidate debt, pay for a home improvement project or maybe even start a business? Both home equity lines of credit (HELOCs) and personal loans allow you to use the proceeds for whatever purpose you need. But which is right for you? We’ll go over the differences between a HELOC versus a personal loan and discuss the alternatives.

Rocket Mortgage doesn’t offer HELOCs currently, but we do offer Home Equity Loans¹ as an alternative. And Rocket Loans offer personal loans.

What is a HELOC and how does it work?

A HELOC is a revolving credit line that uses your house as collateral. You’re approved for a given amount based on your financial qualifications and the value of your home. It’s possible to get a first-lien HELOC, but most often they’re offered in addition to your primary mortgage.

The interest rate would be slightly higher than your first mortgage because the initial lender gets paid first if you default. But it would be lower than a personal loan because the home is the security for the loan.

HELOCs have a draw period at the beginning of the loan. During this time, you can access the funds and the only payments you’re required to make are on the interest of your drawn funds. You can also replenish funds to access them again. Sometime later, the balance freezes during a repayment period and you pay both principal and interest for the remainder of the term.

The terms may vary by lender, but a HELOC, for example, might have a 10-year draw period followed by a 20-year repayment period. It’s also notable that rates tend to be variable on these because the balance changes every month like a credit card.

A lot of HELOCs have a variable interest rate, meaning the rate can go up or down over time based on a benchmark (often the prime rate) plus a margin.

If the rate increases, your monthly payment can increase, sometimes quickly—especially during the draw period if you’re making interest-only payments (because higher interest means higher payments).

HELOCs also tend to come with closing costs, such as origination, appraisal, and title fees. They also might have an application fee or annual fees. Closing costs can be anywhere from 2% to 5% of the loan amount. There's also usually a longer setup time than personal loans and can take two to six weeks from the time you apply to closing.

HELOCs can be used for several purposes. For instance, if you need to take out a large amount for major home improvement projects, such as a phased remodel. That way, you can draw from it as you need, up to the amount of credit available.

What is a personal loan and how does it work?

A personal loan is an unsecured installment loan where you'll receive a lump sum upfront. It comes with fixed payments, which means the payments are usually the same throughout the life of the loan. The length of loan can be anywhere from one to five years.

Because personal loans don't require collateral, lenders usually approve you based entirely on your creditworthiness. This is also known as credit-based or risk-based pricing and is when lenders determine your rates and terms based on how likely it is you'll be able to repay the money borrowed. In turn, having strong credit matters more when you apply for a personal loan than with a HELOC.

And because there's no collateral the lender can take back should you default, interest rates tend to be higher than for a HELOC. However, advantages of a personal loan include a fixed interest rate and in turn fixed payments. Other benefits include a simple application process and speedy funding. In some cases, once you get approved, it can take only one to five business days to receive the funds.

A personal loan can come in particularly handy for one-time expenses, such as debt consolidation. By moving your high-interest debt to a personal loan, which typically has a lower interest rate than credit cards—that is, if you have strong credit, it can save on interest fees.

HELOC vs. personal loan at a glance

It's true that while both HELOCs and personal loans provide access to cash, each comes with its own unique use cases and stipulations. Let's take a side-by-side glance:

How to choose between a HELOC and a personal loan

If you're trying to decide between a HELOC or a personal loan, there's no one-size-fits all. Rather, you'll want to spend time considering different factors to figure out which is a better fit for your situation. That way, you can feel confident in what you choose.
Here are some things you'll want to think about:

One-time expense vs. ongoing needs

The purpose of the funds is often a deciding factor. A personal loan is usually a strong fit for a one-time, specific expense where the full amount is needed up front. For example, for debt consolidation, to cover emergency or moving expenses, or to fund a major life event.

A HELOC often makes more sense for major projects or expenses where you're not entirely sure how much you'll need and that happens over time or in stages.

Remember: It's more about how the money will be used, and no single option is always a better fit than the other. The amount you can borrow with a HELOC will depend on how much home equity you have, your credit score and your lender. You get a home appraisal to help determine how much equity you have. This will also help you and your lender determine your loan-to-value ratio (LTV).

Decide your risk tolerance: Secured vs. unsecured debt

While a HELOC is secured by the home, most personal loans are not, you'll want to gauge how comfortable you are with the possibility of losing your home if you're unable to pay back the money.

If you fall behind on payments with a personal loan—or miss them altogether —you can get dinged with penalties and fees, not to mention damage your credit.

You'll want to figure out whether you fall into one of two camps: If you're more comfortable using the home equity you’ve built, but in a strategic manner. Or, if you prefer to keep the possibility of losing your home out of the equation, even if it can cost you more in interest.

Estimate your timeline to repay

As we've talked about, personal loans usually have a shorter, fixed repayment timeline. This can mean higher monthly payments but a faster payoff. HELOCs, on the other hand, usually can give you a longer repayment horizon. In turn, it can lower your monthly payments and extend the life of your debt.

If you prefer to have more time to pay off your loan, you might fare better with a HELOC. If you can handle a shorter repayment timeframe and prefer to knock out your debt sooner, then a personal loan might be the stronger choice for you.

Compare total cost, not just the interest rate

Focusing only on the advertised rate may end up costing you. That's because the total cost involves the interest over time, any upfront or ongoing fees, and how long the balance is carried. The longer you have the loan, the more you usually end up paying in interest.

A lower rate doesn't always mean a lower total cost if the debt is stretched out. So you'll want to factor in the interest you'll pay over the entire life of the loan, not to mention any other fees.

Stress-test the payment

Going over potential scenarios can help you be well prepared should different scenarios pop up with your HELOC or personal loan.

For HELOCs, as they typically have variable rates, your payments can change over time. If interest rates rise, this can mean a subsequent increase in your monthly payments. Do some simple math to see how much your monthly payments will be with a new increase. Will you be able to afford the bump in payments?

Personal loans, on the other hand, usually come with fixed payments throughout the life of the loan. Should your income change – say, hours at your job are scaled back or you suffer a job loss – will you still be able to afford your monthly financial obligation? 

Factor in near-term life plans

You'll also want to consider any near-life plans on the horizon. These might include:

• Planning to sell the home in the near future
• Anticipating retirement or a career change
• Expecting major expenses or income shifts

You'll want to make sure that the best choice for you today will still make sense a few years down the road. And while there's no universal "best" choice for everyone, the better option will be in sync with your goals, comfort level with risk, financial situation, and timeline.

Next, we'll walk you through the pros and cons of each option. 

When a HELOC might be the better fit

A HELOC might be the stronger choice if:

• You’re funding a project in stages. For example, a major renovation or upgrade that's broken down in phases, or ongoing repairs.
• You need a larger borrowing limit and have substantial equity. HELOCs require you to have at least 15% to 20% of equity in your home, and you can usually borrow up to 85% of the value of your home.
• You can handle a variable-rate movement or have a payoff plan. Should interest rates rise, you'll be able to comfortably deal with the increase in monthly payments.
• You expect to keep the home long enough to justify setup costs. As HELOCs can have an application fee and closing costs, make sure you'll keep the property to make these fees worthwhile.

Here are a few things to watch out for:

• Sudden shifts in payment amounts
• Fees
• The downsides of offering your home as collateral

When a personal loan might be the better fit

Here are a few scenarios where a personal loan might be the stronger choice for you:

• You need a specific amount for a one-time expense. For example, to consolidate debt, to fund an emergency repair, or to cover the costs of a wedding.
• You want fixed payments from Day One. You prefer to have consistent, steady payments throughout the life of the loan.
• You don’t want to use your home as collateral. If you don't want to offer your home as collateral or don't have enough equity to qualify for a HELOC, an unsecured personal loan might be a better fit. 
• You need funds faster and want a simpler process. Often, you can apply for a personal loan online and can receive the funds between one to five business days.

Here are a few things to be on the lookout for:

• Higher potential APR potential
• A shorter term can mean a higher monthly payment
• Fees

Quick pick: Which option is better for you?

Choose a HELOC if…

• You’re a homeowner with enough equity and need flexible access to funds over time.
• You’re financing a longer-term or phased expense, such as home improvements.
• You’re comfortable with variable interest rates and understand that your monthly payments may change.
• You want potentially lower interest rates and are willing to use your home as collateral.

Choose a personal loan if…

• You need a specific amount of money in a lump sum for a one-time expense.
• You want predictable, fixed monthly payments from the get-go.
• You don’t want to use your home as collateral or don’t have enough equity.
• Speed and simplicity matter more than the lowest possible interest rate.

Alternatives to a HELOC or personal loan

HELOCs and personal loans can be good options depending on what you’re trying to do, but they aren’t the only options available. Let’s go over some alternatives to HELOCs and personal loans:

• Home equity loan: Home equity loans are second mortgages. But unlike HELOCs, you get a lump-sum payment as opposed to a line of credit. You could take a look at a home equity loan vs. a personal loan if you already have the budget in mind.
• Cash-out refinance: A cash-out refinance is a lump-sum payment like a home equity loan. Except that instead of taking a second mortgage, you refinance your primary mortgage so that you have one payment.

To decide between a cash-out refi vs. a HELOC or home equity loan, a Rocket Mortgage Home Loan Expert can help you with a blended rate calculation where they take the weighted average of the loan amounts to see which option saves you the most money

• Personal line of credit: A personal line of credit works well for borrowers who want flexible, as-needed access to funds without using their home as collateral. However, interest rates are often higher than HELOCs and interest begins accruing immediately.

FAQ

Here are some frequently asked questions to HELOCs versus personal loans:

Is a HELOC better than a personal loan for home improvements?

A HELOC can be a better fit for home improvements when you have enough equity and want flexibility to borrow over time rather than all at once. HELOC interest rates are often lower than a personal loan. That's because the loan is secured by the home. However, unlike with unsecured personal loans, should payments be missed, this puts your home at risk.

One thing to note: If the funds are used for qualifying home improvements, the interest on the HELOC may also be tax deductible.

Can you use a HELOC or a personal loan for any purpose?

Both a HELOC and a personal loan can generally be used for a wide range of expenses, including home repairs, debt consolidation, medical bills, or big-ticket purchases. Lenders usually don't restrict how personal loan funds are used. And while HELOC funds are tied to home equity, their purpose can also be flexible. Tax treatment and lender terms may vary depending on how the money is used.

What happens if you can’t repay a HELOC vs. a personal loan?

While both personal loans and HELOCs have serious consequences for nonpayment, the difference in whether you offer collateral matters. When it comes to a HELOC, if you're unable to pay it back, because the loan is secured by the home, the lender may pursue foreclosure.

And for personal loans, as most are unsecured, missed payments can mean damaged credit and lead to collections or legal action. However, unsecured personal loans usually don't put the home directly at risk.

Is a HELOC harder to get than a personal loan?

A HELOC often has more qualification requirements because it's secured by your home equity. You'll usually need sufficient home equity, a home appraisal, strong credit, a low debt-to-income ratio, and income history. Note that HELOCs usually have a longer approval timeline than personal loans, and it can take anywhere from two to six weeks from application to funding.

A personal loan, on the other hand, is often faster to apply for and fund. Your approval is usually based primarily on your credit history, credit score, income, and existing debt. That said, which option may be harder to qualify for doesn't depend just on the type of financing, but on the specifics of your situation.

Can you have both a HELOC and a personal loan at the same time?

It is possible to have both a HELOC and personal loan at the same time. You'll need to qualify for each loan and can stay on top of both payments. To make sure you can comfortably afford both at the same time, lenders will take a close look at your debt-to-income ratio and overall financial stability.

While you can take on multiple loans simultaneously, doing so increases financial risk. You'll want to take on extra debt carefully—especially if one loan is backed by your home.

The bottom line: Choosing between a HELOC and a personal loan depends on preferences and goals

A HELOC and a personal loan are both solid borrowing options. One can be a better fit, depending on your home equity, timeline, and risk tolerance.

While a HELOC often features lower interest rates and flexibility, you'll need to offer your home as collateral. A personal loan, on the other hand, features speed and simplicity in the application and approval process. However, it usually has higher interest rates than a HELOC.

Remember: There's no one-size-fits-all. The best option for you depends on how much you need to borrow, how quickly you need the money, and how comfortable you are to tap into your home equity.

If you you’re interested in a home equity loan or cash-out refinance, you can start an application today with Rocket Mortgage. You can use this calculator from Rocket Mortgage to estimate your home equity.

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.