Home Equity Loan vs. Personal Loan: How to Choose

You need to borrow a significant amount—maybe for a renovation, to consolidate debt, or to cover a large expense. Three options are likely on your radar: home equity loans, home equity lines of credit (HELOCs), and personal loans. How they work couldn't be more different.

Home equity products often come with lower interest rates, and they put your home on the line. Personal loans carry no collateral requirement. The lower risk typically comes at a higher cost.

Which one makes sense depends on your equity, your credit, your timeline, and your comfort with risk. What follows gives you a framework for the decision.

How each loan works

While they share similarities, each type of loan works differently.

How a home equity loan works

A home equity loan lets you borrow against the equity you've built in your home, which is the difference between what it's worth and what you still owe. You receive a lump sum and repay it at a fixed interest rate in fixed monthly installments. Lenders generally prefer that you retain at least 15% to 20% equity after borrowing.

How a HELOC works

A home equity line of credit, or HELOC, works more like a credit card. Instead of a lump sum, you get a revolving credit line you can draw from as needed during a draw period, which commonly lasts around 10 years. A repayment period follows, often lasting 10 to 20 years depending on the lender and terms. Most HELOCs carry a variable interest rate, though fixed-rate and convertible-rate options are available with some lenders. Total borrowing, including the new loan, can reach up to 90% of your home's value.

How a personal loan works

A personal loan usually requires no collateral, though some lenders offer secured options. You repay it at a fixed interest rate over a set term, usually one to seven years. Loan amounts commonly range from $1,000 to $100,000 or more, with some lenders offering amounts that overlap with home equity territory. Your credit score and income drive both your eligibility and the rate you'll receive.

Key differences at a glance

Here's how the three products compare across the factors that matter most:

The most important difference you need to understand

With a home equity loan or HELOC, your home is the collateral—it backs up the loan. If you can't repay the loan as agreed, the lender could foreclose and you could lose your home. 

With an unsecured personal loan, you don't put collateral at risk. You could still face significant credit damage and a lawsuit if you don't repay the loan, but your home isn't directly at risk.

You need to be comfortable with using your home as collateral if you're going to get a home equity loan or HELOC.

Which loan is right for your situation

The right loan will depend on a lot of factors.

• Consider a home equity loan if: You know the exact project cost and want predictable fixed payments. It's generally well-suited for debt consolidation, medical bills, home additions and large renovations, or a down payment on another property—any situation where you need a set amount at a fixed rate. 
• Consider a HELOC if: Costs are uncertain or phased, you want flexibility to draw over time, or you want a credit line available for emergencies, periodic expenses like college tuition, or as a business backstop. Fee-free HELOCs are widely available.
• Consider a personal loan if: You need funds fast, don't own a home or have only limited equity, want to avoid putting your home at risk, or your project is smaller in scope. Renters and newer homeowners who haven't built equity don't have access to equity products. A personal loan is the straightforward path.

Another big differentiator may be what you're using the funds for. The interest from home equity loans and HELOCs could be tax deductible if the funds are used to improve your home. The same isn't true for other uses, such as consolidation. Consult with a tax professional for details about your specific situation.

Home equity loans and lines of credit can deliver lower payments than personal loans because their terms are generally longer and their interest rates generally run lower. Understand, though, that extending repayment can increase your overall expense, even with a lower interest rate. It’s a trade-off to be aware of. 

Also, personal loan interest rates vary a great deal based on your credit. Borrowers with strong credit tend to get lower rates; those with fair or poor credit may pay significantly more. Borrowers with excellent credit may find personal loan rates competitive with home equity rates.

What lenders look at when you apply

Home equity products are mortgages, so the amount you can borrow depends largely on the home's value compared to what you currently owe. These loans are also subject to guidelines relating to your income, credit history, and score. 

For example, a lender might allow total financing of no more than 85% of your home’s value and require a credit score of at least 620 and a maximum debt-to-income ratio (DTI) of 43%.

When it comes to unsecured personal loans, your credit score and income are the primary drivers of approval. No home equity is required, but you may need to meet stricter credit requirements and have a lower DTI.

A few common scenarios:

• Strong equity, fair or better credit: Equity products are accessible, though your credit score affects the rate you're offered.
• Great credit, no equity: A personal loan is your path; equity products aren't an option.
• Limited equity, good credit: a personal loan is often faster and simpler.

Many personal loan lenders offer prequalification using a soft credit pull, with no hard inquiry required. Not all lenders offer this, so confirm before applying.

Bills Action Plan

1. Decide on your purpose. Know what you're borrowing for: a one-time expense with a firm cost, a phased project, or debt consolidation. Ask yourself whether you're comfortable putting your home at risk for a lower rate and/or payment.
2. Check your equity and credit. Get a current estimate of your home's value and your remaining mortgage balance. Pull your credit report at AnnualCreditReport.com (free, no score impact). These two numbers could narrow your options quickly.
3. Compare both paths before committing. Prequalify for a personal loan with at least a few lenders that use a soft credit pull. Get a home equity estimate from your bank or credit union. Compare personal loan options and weigh total cost over the life of the loan, not just the interest rate.

Key Terms

Home equity: The portion of your home's value you own outright. That's your current market value minus what you still owe on your mortgage.

HELOC: A revolving credit line secured by your home equity. You draw from it during a set draw period, then repay what you borrowed.

Home equity loan: A lump-sum loan secured by your home equity, repaid in fixed monthly installments at a fixed interest rate.

CLTV (combined loan-to-value ratio): Your total loan balances, including your mortgage and any new loan, divided by your home's appraised value. Lenders use this to determine how much you may borrow.

Collateral: An asset (something of value you own) pledged to secure a loan. With home equity products, your home serves as collateral and is at risk if you default.

Draw period: The phase of a HELOC during which you can borrow against your credit line. Payments are interest-only with many lenders during this period, though not all require this structure. This content is for general educational purposes. Bills.com is not a lender. Rates, terms, and eligibility vary by lender and are subject to credit approval. Tax deductibility of home equity interest depends on how loan proceeds are used, so consult a qualified tax advisor for advice specific to your situation.