Why Does a HELOC Make More Sense than a Personal Loan?

Two common ways to borrow money when you’re looking to secure the funds necessary for major expenses like a renovation, college tuition, or even debt consolidation are a home equity line of credit (HELOC) and a personal loan. But there are clear reasons why a HELOC makes more sense in many situations than a personal loan. Let’s start with a quick definition of each.

Home Equity Line of Credit (HELOC)

A home equity line of credit or HELOC is a revolving line of credit that uses your home as collateral. It provides you with access to a predetermined credit limit which you can borrow from as needed. A HELOC works more like a credit card in that you can borrow and repay repeatedly within the draw period, which usually lasts around 5-10 years. During the draw period, you pay interest on the amount borrowed. After the draw period ends, you may enter the repayment period, during which you can no longer borrow and must repay both principal and interest. The interest rates on a HELOC may be variable, meaning they can fluctuate over time.

Personal Loan

A personal loan is typically an unsecured loan that doesn’t require using your home or property as collateral but instead only considers things like credit history and income. With a personal loan, you usually receive a lump sum of money upfront with scheduled monthly payments made over a set period. Loan amounts, qualification standards, and terms vary.

Advantages of a HELOC

• Flexibility in borrowing: A HELOC offers a revolving line of credit so you can borrow from the credit line as needed, up to the predetermined limit, during the draw period. This flexibility allows you to access funds as required, rather than borrowing a fixed amount all at once.
• Pay interest only on what you borrow: With a HELOC, you only pay interest on the amount you borrow during the draw period, not on the entire credit limit. This can be advantageous if you have sporadic borrowing needs or if you prefer to have a safety net of available funds without accruing interest until you actually use the money.
• Variable interest rates: A HELOC often comes with variable interest rates, which means the interest rate can fluctuate over time based on changes in the market. If interest rates decrease, you may benefit from lower borrowing costs. However, it’s important to consider potential rate increases and how they might impact your repayment ability.
• Flexible repayment options: Depending on the terms of the HELOC, you may have the option to make interest-only payments or choose to pay both principal and interest. This flexibility can be helpful for managing cash flow and aligning your repayment strategy with your financial situation.
• Access to funds over time: With a HELOC, you can access funds as needed over an extended period, allowing for ongoing borrowing and repayment cycles. This can be beneficial if you have long-term projects, multiple expenses, or irregular income streams. You can tap into your credit line whenever necessary, without having to reapply for a loan each time.

Disadvantages of a Personal Loan

• Costly interest rates: Personal loan interest rates can be costly, particularly if your credit score is low. A long repayment timeline or a high interest rate could limit its effectiveness in helping you achieve your goal.
• Payment schedule: You have a payment schedule until the repayment period is over.
• Prepayment penalties: These are fees that can be charged when you bring the loan’s balance to zero or pay the loan down significantly, prior to the loan’s payoff date. Some lenders charge them to make up for the money they expected to earn from the eventual interest.
• Origination fees: These are the fees the lender charges to cover its costs in the process and can range from 1% to over 10% of the amount borrowed.
• Credit score impact: If you don’t make all of your payments on time, a personal loan could hurt your credit score. You could also see a reduction in your credit utilization ratio, especially if you’re paying off piles of credit card debt.

Putting It All Together

A HELOC offers homeowners a range of benefits to unlock the financial potential of their properties. Leveraging your home equity can provide access to large loan amounts, lower interest rates, and potential tax benefits. By harnessing the power of home equity, you can take control of your finances set yourself on a path to reaching your financial goals.

At Norway Savings Bank, we want to simplify the borrowing process. Our local lending experts meet you where you are, take time to understand your needs, and when we’ve found the right option, we make the application process fast and easy. We’re here to help. Ready to get started? Contact a lender! Also, visit NSB’s Home Equity Resources Hub which features a number of helpful articles that can assist you in your process.

This article was written by NSB residential lending experts, not generated from artificial intelligence.