Are you considering applying for a personal loan to consolidate your debts or pay for major expenses? Many homeowners choose to take out these unsecured loans. Still, they may not be aware of the various personal loan disadvantages or why a home equity line of credit (HELOC) could be a much better option.
While personal loans are widely available and somewhat easy to understand, they also have notable downsides that can make them less appealing compared to other financing options.
In this article, we’ll explore the disadvantages of personal loans compared to HELOCs and show you how to choose the most flexible and cost-effective home funding option.
What are personal loans?
A personal loan is an unsecured loan that provides a lump sum of money. Repayment is made over a set period, typically 2 to 7 years, with fixed payments.
These loans are commonly used to consolidate high-interest credit card debt, fund home improvements, or cover unexpected expenses.
Since personal loans are unsecured, lenders don’t require collateral, such as your home or car, to approve the loan. This accessibility makes personal loans attractive, but their drawbacks can outweigh the benefits in many situations.
Personal loan disadvantages
While personal loans can be convenient in certain scenarios, they come with several significant downsides that borrowers should carefully consider before applying.
1. High interest rates
Because personal loans are unsecured, lenders take on greater risk, which often translates to higher interest rates for borrowers.
The average interest rate for personal loans ranges from 10% to 28% or more, depending on your credit score.
By contrast, secured loans like HELOCs typically offer much lower interest rates because they use your home as collateral.
For borrowers with good credit, the interest savings from a HELOC can be substantial compared to a personal loan.
2. Limited borrowing amounts
Personal loans often have stricter borrowing limits, with maximum amounts typically ranging from $25,000 to $50,000.
This can make personal loans insufficient for larger financial needs, such as extensive home renovations or significant debt consolidation.
On the other hand, HELOCs allow you to borrow based on the equity in your home, with limits often exceeding $100,000 or more, depending on your property’s value and equity.
3. Fixed repayment terms
Fixed repayment terms are fairly standard with personal loans, meaning you must repay the loan within a set period, typically 2 to 7 years.
While predictable payments can be useful, that lack of flexibility could become a problem if your financial circumstances change.
In contrast, HELOCs offer a draw period during which you can borrow as needed and pay interest only on the amount you use. This flexibility makes HELOCs a more adaptable option for homeowners.
4. No potential tax benefits
Unlike HELOCs, personal loans do not offer any tax advantages. Interest paid on personal loans is not tax-deductible, regardless of how you use the funds.
However, interest on a HELOC might be tax-deductible when the funds are used for qualified home improvements. While this doesn’t apply to all uses of HELOCs, it’s an important potential advantage for homeowners looking to invest in their property.
5. Credit score dependency
Approval for personal loans—and the interest rate you receive—heavily depends on your credit score.
Borrowers with lower credit scores may face prohibitively high interest rates or struggle to qualify for a personal loan.
Because your home secures HELOCs, lenders are often more lenient, making it easier for homeowners with less-than-stellar credit to qualify for a HELOC at favorable rates.
Why HELOCs are better than personal loans
For homeowners, a home equity line of credit (HELOC) offers several advantages over personal loans, making it a better choice for many financial needs.
1. Lower interest rates
HELOCs typically offer significantly lower interest rates compared to personal loans.
Since your home secures a HELOC, lenders can offer more competitive rates, helping you save money on interest over time.
For example, while a personal loan might have an interest rate of 15% or higher, a HELOC rate may start as low as 6% or 7% for qualified borrowers, depending on market conditions.
2. Flexible borrowing
Unlike personal loans, which provide a lump sum, HELOCs function as a revolving line of credit.
This means you can borrow as much or as little as you need, up to your credit limit, during the draw period. You also pay interest only on the amount you borrow, not the full credit limit.
This flexibility makes HELOCs ideal for expenses that arise over time, such as ongoing home improvement projects or fluctuating medical costs.
3. Higher borrowing limits
Because the equity in your home secures HELOCs, they often come with much higher borrowing limits than personal loans.
This makes them better suited for substantial expenses, such as major renovations or consolidating large amounts of high-interest debt.
4. Tax advantages
As mentioned earlier, the interest on a HELOC may be tax-deductible if your funds are used for qualified home improvements. This can reduce your overall borrowing costs and make a HELOC an even more attractive option for homeowners.
5. Tailored repayment options
HELOCs offer flexible repayment options, allowing borrowers to make interest-only payments during the draw period.
After the draw period ends, borrowers can repay the principal and interest over the repayment period, typically lasting 10 to 20 years.
This structure provides greater financial flexibility compared to personal loans, which have fixed repayment terms from the start.
Ditch the personal loan: Take advantage of HELOCs
While personal loans may seem convenient, their disadvantages—such as high interest rates, limited borrowing amounts, and lack of flexibility—can make them less appealing to homeowners.
A HELOC offers a more flexible, cost-effective solution for those with home equity. With lower interest rates, higher borrowing limits, and potential tax advantages, HELOCs are a smart choice for covering major expenses or consolidating debt.
HomeEQ takes HELOCs to the next level when accessing your home equity with a streamlined, fully digital application process that prioritizes speed, simplicity, and borrower satisfaction.
Explore your loan options today with HomeEQ and unlock the full potential of your home equity.