If you’re looking for a tool you can use to borrow money when you need it, you may be wondering which is the better choice: a personal line of credit or a home equity line of credit (HELOC).
In this guide we’ll look at the similarities and differences of these two types of credit lines — both of which function similarly to a credit card, but typically have a lower interest rate and a higher credit limit. We’ll also cover some of the pros and cons of using a personal line of credit vs. a HELOC.
What Is a Personal Line of Credit?
A personal line of credit (LOC) is a revolving credit account that allows you to borrow money as you need it, up to a preset limit.
Instead of borrowing a lump sum and making fixed monthly payments on that amount, as you would with a traditional installment loan, a personal line of credit allows you to draw funds as needed during a predetermined draw period. You’re required to make payments based only on your outstanding balance during the draw period.
In that way, a personal LOC works like a credit card. Generally, you can pay as much as you want each month toward your balance, as long as you make at least the minimum payment due. And the money you repay is added back to your credit limit, so it’s available for you to use again.
You can use a personal LOC for just about anything you like, as long you stay within your limit.
A personal LOC is usually unsecured debt, which means you don’t have to put up collateral. The lender will base decisions about the amount you can borrow and the interest rate you’ll pay on your personal creditworthiness.
Can a Personal Line of Credit Be Used to Buy a House?
If you could qualify for a high enough credit limit — or if the property you want to buy is being sold at an extremely low price — you might be able to purchase a house with a personal LOC. But it may not be the best tool available.
A traditional mortgage secured by the home that’s being purchased may have lower overall costs than a personal LOC and could potentially have tax benefits for the mortgage holder.
Variable interest rates, which are typical with personal lines of credit, might not be the best option for a large purchase that could take a long time to pay off. Your payments could go lower, but they also could go higher. If interest rates increase, your loan could become unaffordable.
If you use all or most of your personal LOC to make a major purchase like a home, it could have a negative impact on your credit score and future borrowing ability. The amount of revolving credit you’re using vs. how much you have available is an important factor in your credit score calculation, and lenders typically prefer this number to be less than 30%.
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What Is a HELOC?
A home equity line of credit, or HELOC, is a revolving line of credit that is secured by the equity a borrower has in their home.
Lenders typically will allow you to use a HELOC loan to borrow up to 85% of your home’s current appraised value minus the amount you currently owe. A lender also may review your credit score, credit history, employment history, and debt-to-income ratio (monthly debts ÷ gross monthly income = DTI) when determining your borrowing limit and interest rate.
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Personal Line of Credit vs HELOC Compared
If you’re comparing a personal line of credit vs. a home equity line of credit, you’ll find there are many similarities. But there are some important differences to keep in mind as well.
Here are some ways in which a personal LOC and a HELOC are alike:
• They’re both revolving credit accounts, on which loan funds can be borrowed, repaid, and borrowed again, up to the credit limit.
• Both have a draw period and a repayment period. The draw period can typically be up to 10 years, with monthly minimum payments required. The repayment period may be up to 20 years after the draw period ends.
• Access to funds is convenient. Withdrawals can be made by check or debit card, depending on how the lender sets up the loan.
• Lenders may charge monthly fees, transaction fees, or late or prepayment fees on either. It’s a good idea to understand potential fees before closing.
• Both typically have variable interest rates, which can affect the overall cost of the line of credit over time.
The biggest difference between a HELOC and a personal LOC is that a HELOC is secured by the borrower’s home, while a personal LOC is typically unsecured. That can impact the borrower in a few ways, including:
• Interest rates and credit limits can vary. In exchange for the risk HELOC borrowers take (they could risk losing their home if they default on their payments), they generally qualify for lower interest rates. HELOC borrowers also may qualify for a higher credit limit.
• With a HELOC, the lender may require a current property appraisal, which might slow down the approval process and be an added expense.
• Approval for an unsecured personal LOC is typically based on the applicant’s creditworthiness. That can make the application process easier, because you probably won’t have to do as much paperwork. But you may need a better credit score and meet other financial benchmarks to qualify for a personal LOC than you would for a HELOC.
• A borrower assumes the potential risk of losing their home if they default on a HELOC. An unsecured personal LOC does not come with a risk of that significance.
Comparing Personal Line of Credit vs. Home Equity Line of Credit
|Flexible borrowing and repayment||✓||✓|
|Convenient access to funds||✓||✓|
|Annual or monthly maintenance fee||Varies by lender||Varies by lender|
|Variable interest rate||✓||✓|
|Secured with collateral||Typically unsecured||✓|
|Approval based on creditworthiness||✓||✓*|
|Favorable interest rates||✓**||✓**|
*Credit and income requirements may be tougher for unsecured personal loans than secured loans.
**Interest rates can vary based on several factors. Rates may be lower for a secured personal LOC than for an unsecured personal LOC, and personal LOC rates, in general, are typically lower than credit card rates.
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Pros and Cons of HELOCs
A HELOC works much like a personal LOC, so they share many of the same pros and cons. An added advantage of borrowing with a HELOC, however, is that because it’s secured, the interest rate may be more favorable than that of a personal LOC.
Another plus is that a HELOC may offer a tax benefit. If you use the money to buy, build, or substantially improve the home that secures the loan, and you itemize deductions on your income tax return, you may be able to deduct your HELOC interest payments.
The downside is that if you can’t make your HELOC payments, you risk losing your home. Also, if your home loses value and your equity decreases, the lender may terminate the HELOC or lower your borrowing limit.
Pros and Cons of HELOCs
|Flexibility in how much you can borrow and when.||Your home is at risk if you default.|
|Interest charges are based only on the amount borrowed during the billing period.||Variable interest rates can make repayment unpredictable and potentially expensive.|
|Generally lower interest rates than credit cards or unsecured borrowing.||Lenders may require a current home appraisal for approval.|
|Possible tax advantages.||A decline in property value could impact the credit limit or result in termination of the HELOC.|
Pros and Cons of Personal Lines of Credit
A personal LOC has both advantages and disadvantages when compared to a HELOC, credit cards, and installment loans.
Because you draw just the amount of money you need at any one time, instead of a lump sum, a line of credit can be a good way to pay for a renovation project, ongoing medical or dental treatments, a wedding, or other expenses that might be spread out over time. You pay interest only on the funds you’ve drawn, not the entire line of credit that’s available, which can keep monthly costs down. As you make payments, the line of credit is replenished, so you can borrow the money repeatedly during the draw period. And with an unsecured personal LOC, you don’t have to worry about coming up with collateral.
But there are downsides to be wary of, as well. Here’s a summary of some of the pros and cons of a personal LOC.
Pros and Cons of Personal Lines of Credit
|Flexibility in how much you borrow and when.||Variable interest rates can make repayment unpredictable and potentially expensive.|
|Interest charges are based only on what you’ve borrowed.||Interest rates may be higher than for a secured line of credit or secured loan.|
|Interest rates are typically lower than credit cards.||Qualification can be more difficult than for secured credit.|
|You aren’t putting your home or another asset at risk if you default.||Convenience and minimum monthly payments could lead to overspending.|
Alternatives to Lines of Credit
As you consider the pros and cons of a HELOC vs. a personal LOC, you also may wish to evaluate some alternative borrowing strategies, including:
A personal loan is an installment loan, which means a borrower receives a lump sum of money from the lender and makes fixed monthly payments, with interest, until the loan is repaid.
Most personal loans are unsecured, so the interest rate and other terms are determined by the borrower’s credit score, income, debt level, and other factors.
You lose some flexibility because the credit limit doesn’t replenish as you make payments, and you’ll owe interest from day one on the full amount that you borrow. But if you’re using the loan to make a large purchase, to consolidate debt, or to pay off one big bill, it may make sense to borrow a specific amount and budget around the predictable monthly payments.
Personal loan interest rates and other costs can vary significantly depending on the lender, the borrower, and the terms of the loan. You can use a loan comparison site to check multiple lenders’ rates, or you can go to the lenders’ individual websites to find a personal loan interest rate that’s a match for your goals.
If you’re getting a personal loan to buy a car, you may want to consider the pros and cons of an auto loan. An auto loan is an installment loan that’s secured by the car being purchased, so qualification may be easier than for an unsecured personal loan or personal LOC.
Most auto loans have a fixed interest rate that’s based on factors like the applicant’s creditworthiness, the loan amount, and the type of vehicle that’s being purchased.
If you buy a vehicle using an auto loan, you won’t receive the lump sum payment ahead of time, as you would with a personal loan. Instead, you’ll be given an approval letter, and the funds will go directly to the dealer or online shopping platform you’re working with.
Down the road, if you think you can get a better interest rate — perhaps because interest rates have gone down or because you’ve improved your credit score — you can always look into refinancing your auto loan with a personal loan or personal LOC.
A mortgage is an installment loan that is secured with the property you purchase with the loan funds.
There are many different types of mortgage loans, and terms can vary substantially depending on the loan and lender you choose. You’ll likely need a down payment to get the loan, and buyers typically pay closing costs equal to a percentage of the purchase price.
A mortgage may have a fixed or adjustable interest rate. An adjustable-rate mortgage typically starts with a lower interest rate than its fixed-rate counterpart, which can be appealing to buyers. But the rate can fluctuate over time, based on the underlying benchmark interest rate or index it’s tied to. With a fixed-rate mortgage, the interest rate stays the same for the life of the loan.
Your ability to qualify for the mortgage terms you want may depend on your creditworthiness, your down payment amount, and the value of the home you plan to buy.
A credit card is a revolving line of credit that may be used for day-to-day purchases such as groceries, gas, online shopping, or automatic payments on recurring bills.
Convenience can be one of the best things about using credit cards, but it can also be one of the worst. You can use them almost anywhere to pay for almost anything. But it can be easy to accrue debt you can’t repay.
Because credit cards are unsecured in most cases, interest rates can be higher than for other types of borrowing. And if you miss payments or make late payments, the credit card issuer may increase your interest rate. Making late payments or using a high percentage of your credit limit also can have a negative effect on your credit score.
If you manage your credit cards wisely, however, they can have some useful benefits, including cash-back rewards, travel points, and other perks. And if you have solid credit, you may be able to qualify for a low- or no-interest introductory offer that can be a helpful strategy for financing a purchase if you can pay the balance in full before the promotional period ends.
Credit card issuers typically base a consumer’s interest rate and credit limit on their credit score, income, and other financial factors.
If you’re borrowing money specifically to pay for college expenses, it’s a good idea to start by filling out the Free Application for Federal Student Aid (FAFSA®), to see what types of federal student financial aid are available to you. Federal student loans typically offer lower interest rates and more borrower protections than private student loans or other lending options.
But if the federal student financial aid you’re eligible for isn’t enough to cover your education costs, it could be worth comparing what private lenders might offer. Student loan need-to-knows might include interest rates, flexibility of terms, fees, application process, and any benefits for qualifying borrowers.
A line of credit can be a useful tool for borrowers whose costs are spread out over time, the way they often are when you’re planning and paying for a wedding, a home renovation, or medical treatments. Both HELOCs and personal LOCs can have advantages for borrowers, especially those who don’t want to pay interest from day one on a lump-sum loan that may be more money than they need.
If you’re comfortable putting up your home as collateral, a HELOC may be the right choice for you. But if you aren’t a homeowner, or if you’d prefer not to secure the line of credit with your home, a personal LOC may be a better fit.
If a line of credit isn’t the right option for you, a Personal Loan may be something to consider. An unsecured personal loan from SoFi has low fixed rates, no fees, and terms that will fit a variety of budgets. You can check your rate in just one minute without affecting your credit score.*
Can you use a personal LOC to purchase a home?
If you qualify for a high enough credit limit — or if the property you hope to buy is being sold at an extremely low price — you might be able to purchase a home with a personal LOC. But a mortgage or other option with a lower and fixed interest rate may be a better solution.
What happens if you don’t use your home equity line of credit?
Having a HELOC you don’t use could give your credit score a boost if it improves your credit utilization ratio (the amount of revolving credit you have available vs. how much you’ve used).
Does a HELOC actually increase your mortgage payments?
The HELOC is a separate loan from your mortgage. The two payments are not made together.
*Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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