Home Equity Loan vs. Personal Loan

When it comes to home equity line of credit vs personal loan, securing consolidated debt with collateral can be a risky proposition.

Using a home equity loan to consolidate credit card debt can be extremely helpful. With the right credit score, you can qualify for a loan at a low interest rate. This allows you to pay back what you owe in a more efficient way. It minimizes the total cost of debt elimination and often means that you pay less each month, too.

However, although loans can be useful for consolidating debt, not all loans are equal for this purpose. The information below helps you understand the key difference between consolidating with these two types of loans.  If you have questions or need to discuss your best options for debt relief with a certified professional, we can help. Call Consolidated Credit at (844)-402-3073 to schedule a consultation with a credit counsellor at no charge. You can also complete our online application.

Home Equity Line of Credit vs Personal Loan:

What is a home equity line?

A home equity line or home equity line of credit (HELOC) is a secured form of borrowing. The lender is using your home as collateral that you’ll pay back the HELOC. Otherwise, it can foreclose on your home or initiate a power of sale.

HELOCs are revolving in nature. That means that you can borrow money as needed and you only pay interest on the money that you borrow. It also means that you can borrow money, pay it back and then reborrow it again as needed.

There are two types of HELOCS. You can take out a standalone HELOC or a HELOC combined with your mortgage.

A standalone HELOC is like a second mortgage. It’s separate and apart from the main mortgage that you have. You may be able to have a HELOC at the same or a different lender where your mortgage is at.

A HELOC combined with your mortgage is also referred to as a readvanceable mortgage. The advantage of this is that as you pay down your mortgage, your HELOC limit increases. The increase is based on the principal portion of your regular mortgage payments.

An Example

Let’s say your regular mortgage payments are $2,000 per month, with $1,000 of that amount being principal. With a readvanceable mortgage, if your HELOC credit limit was $50,000, each time you made a regular mortgage payment, your HELOC limit would increase by $1,000. After your first payment it would be $51,000, then $52,000 and so on.

This is different than a home equity loan where similar to a personal loan it’s for a fixed amount at a fixed interest rate. A home equity loan is a lot less flexible than a HELOC. You’ll start paying interest and making payments on it immediately, even if you don’t need the full amount. A home equity loan can make more sense if you want to force yourself to pay back money within a set timeframe.

Many people use the terms home equity loans and HELOCs interchangeably when they’re actually different.

HELOCS are revolving credit. You can borrow money, pay it back, and borrow it again, up to a maximum credit limit.

That’s different from home equity loans where once you pay it off, you need to reapply again to access to the funds. Furthermore, you’re required to make regular payments with home equity loans, whereas you can make interest-only payments with HELOCs.

Are you still confused about the differences between the two? You can check out this page for more details on the difference between HELOCs and home equity loans.

What is a personal loan?

A personal loan is a loan where you borrow a fixed amount for an agreed upon period of time. When you sign up for a personal loan, you’re agreeing to repay the full amount, plus interest and any fees. This is done by making regular loan payments, referred to as instalments.

Personal loans are usually for a specific reason, such as debt consolidation, home renovations or furniture. Personal loans also usually range in amount from as little as $100 to as much as $50,000. The repayment term is usually between six months and 60 months.

You can take out a personal loan from banks and credit unions. If you don’t qualify at the banks due to bruised credit or a lack of income, you can apply for a personal loan with an alternative or private lender (although the interest rate will be higher and there may be additional fees).

You may be offered a loan for more than you need. Also extra fees may be tacked on. Be careful not to get in over your head.

A personal loan is usually unsecured. This means that there isn’t an asset backing it. When there’s an asset such as your home backing it, it may be referred to as a home equity loan.

Collateral makes all the difference

The difference between a home equity loan and personal loan is collateral. A personal loan is unsecured debt, meaning it is not backed up by collateral. If you default on unsecured debt due to nonpayment, the lender must sue you in civil court to recoup losses.

By contrast, a home equity loan is secured debt. You borrow against the value of your home. This means your home acts as collateral. If you default on a secured debt, the collateral can be taken without an additional court order. In other words, if you fall behind on the payments, you could be at risk of foreclosure.

Securing a loan usually means better rates with a lower credit score…

People often turn to home equity loans because it’s easier to get approved. A secure loan means you can qualify for a lower interest rate without a need for excellent credit.  The lender relaxes their lending standards because the loan is back up using your home as collateral. That means less risk for the lender, which leads to better rates and lending terms.

This is why using a home equity loan to eliminate credit card debt can be so tempting. You can get a low interest rate and good terms even with a weaker credit score. It can seem like a good path out of debt. As long as you keep your job and keep up the payments, you can pay off the loan without trouble.

… But the risk you add is often not worth the cost savings

However, experts usually agree that the rate reduction and ease of qualifying is not worth the risk. As mentioned above, borrowing against the value of your home is fine as long as your financial situation doesn’t change. Still, financial changes happen even if you don’t intend them. You could lose your job, the real estate market could take a bad turn, and suddenly your home is at risk of foreclosure.

Now consider the risk if you’re in the same situation with an unsecured personal loan. You can still consolidate your credit cards at a lower interest rate. However, now if your finances take a turn for the worse, you won’t lose anything if you default. If you default on the unsecured loan, it may pass to a third-party collector.  The lender or collector would have to sue you in civil court to recoup any losses. You might face a lien or wage garnishment, but your home would be protected from foreclosure.

If you can’t qualify for unsecured, consider other options before you tap equity!

When seeking debt relief for unsecured credit card debt, it’s best to keep your solution unsecured as well. If you’re looking into do-it-yourself debt consolidation, see if you can qualify for an unsecured personal debt consolidation loan.  This would consolidate your credit card debts into a single monthly payment at a low interest rate.

If you can’t get approved or don’t qualify at a good rate, a home equity loan SHOULD NOT be your next step. Instead, you should talk to a credit counsellor to review your other options. They may recommend that you enroll in a debt management program. This helps you avoid using a home equity loan that would just increase your risk unnecessarily.

Another risk with reconsolidation

In addition to the risk of collateral, using a home equity loan for credit card debt also creates another challenge. Namely, you can’t re-consolidate later if your debt elimination plan doesn’t work.

When you consolidate with an unsecured personal loan it means that the debt remains unsecured. This means you can re-consolidate the loan later with another debt relief option if you need to do so. Your options for debt relief remain open. You can take out another consolidation loan or you can include the consolidation loan in a debt management program.

On the other hand, if you consolidate with a home equity loan the debt is now secure. That means you can’t include it in any unsecured debt relief option. For instance, it would no longer be eligible for inclusion in a debt management program.

Pros and cons of personal loans

Still trying to decide whether a personal loan is right for you? To make your decision easier, here’s a summary of the pros and the cons of personal loans.

Pros:

  • The majority of personal loans come with regular monthly payments. This helps ensure you pay it off eventually.
  • Besides fixed regular payments, you can also expect a fixed interest rate. That means you don’t have to worry about your interest rate jumping during the term of your personal loan.
  • Once the term of your personal loan is over, your debt no longer exists. That’s presuming you make all the payments in full and on time.
  • A personal loan may come with a lower interest than an unsecured line of credit, helping you save money.
  • A personal loan may be ideal for debt consolidation. You’ll only have one monthly payment to worry about (instead of several) and you’ll benefit from a lower interest rate, helping you reach debt freedom sooner.
  • A personal loan can be a great way to build or rebuild credit. By consistently making your payments on time and in full, it shows lenders you’re a responsible borrower. This can make it easier to qualify for a bigger loan (i.e. a mortgage) later on at the best available mortgage rates.

Cons:

  • You must make regular monthly payments. There may be little flexibility if you run into financial difficulty and have trouble making your monthly payments.
  • You may find it tough to afford regular monthly payments from a cash flow perspective, especially if you’ve taken a pay cut or you lose your job.
  • There is interest on the full amount you borrow right away, whether you need the full amount now or not.
  • Personal loans may be tougher to qualify for, especially if you’re a senior on a fixed income. Lenders usually look at your income, credit and other debts when deciding whether to approve you or not.
  • The interest rate on a personal loan is almost always higher than a home equity loan. That’s because unlike a home equity loan, there’s no asset to secure it. As such it will take you longer to pay off your debt and cost you more in interest.
  • If you have a small amount of debt, it may not be worth it to take out a small personal loan to pay it off.

For a full listing of the pros and cons of home equity loans, check out our Home Equity Loan vs. HELOC page.

Always consult an expert before you access home equity

You have options when considering home equity line of credit vs personal loan choices. In some circumstances, using a home equity loan to take advantage of your equity can be a smart financial move. However, you should always consult with a certified professional before you move forward. Call Consolidated Credit at (844)-402-3073 to speak with a counsellor. Together you can evaluate the risks and benefits before you make any lending decision.

Talk to a trained credit counsellor now to zero in on the right debt solution for your needs.

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