Sandra MacGregor
Beth Buczynski
Personal lines of credit and home equity loans are both ways to borrow money. A line of credit borrows money from a financial institution, while a home equity line essentially allows you to borrow money from yourself.
Knowing which one of these financing options is right for your situation will depend on your credit score and debt, how much money you need to borrow and whether or not you own a home with equity that might be tapped.
How a personal line of credit works
A personal line of credit is a type of revolving credit that works similarly to a credit card.
Funds from a personal line of credit can be drawn, paid off and then withdrawn again continuously as long as you make your required monthly payments.
Interest rates on a line of credit are usually variable (though it may be possible to get a fixed rate) and fluctuate based on changes to your lender’s prime rate.
Getting approved for a line of credit, and the interest rate you’re offered, is contingent on your credit score, income, current debt load and other factors.
It’s worth noting that a line of credit is not normally secured. The most common way to get a secured line of credit is by using your home as collateral, which is known as a home equity line of credit, or HELOC.
How a home equity loan works
In Canada, a home equity loan is sometimes referred to as a second mortgage. Home equity loans are different from HELOCs (though the two are often confused, as both are ways to tap into the equity you’ve built in your home).
A home equity loan gives you a one-time, lump-sum payment that you then pay back according to a set monthly repayment schedule, much like your mortgage.
With a home equity loan, you’re typically eligible to borrow up to 80% of the value of your home minus any remaining balance you still owe on your original mortgage. If you get a home equity loan, you’ll be responsible for making payments on both your first and second mortgages at the same time.
Interest rates can be fixed or variable on a home equity loan. To compensate creditors of second mortgages for taking on a greater risk, interest rates for home equity loans tend to be higher than on first mortgages or on lines of credit. Because of this, home equity loans are usually sought by people with lower credit scores or less equity, which may put a HELOC or other alternatives out of reach.
Home equity loans vs personal lines of credit
| Home equity loan | Personal line of credit | |
|---|---|---|
| Common uses | Large purchases with a predictable budget. Debt consolidation. | Large purchases where the budget might change over time, such as home renovations. Debt consolidation. Emergency expenses. |
| Where to get it | Banks, credit unions and some alternative lenders | Banks, credit unions and some alternative lenders |
| Typical loan repayment terms | Between 5 and 30 years. | Ongoing. |
| Typical loan limits | Up to 80% of a home's value, minus any balance that remains on the first mortgage. | $5,000 to $50,000 |
| Typical interest rates | 10% to 15%, depending on the lender and borrower's credit profile. | Typically a few percentage points higher than a bank’s prime rate, though introductory rates equal to prime may sometimes be available. Alternative lender rates can be as high as 46%. |
| Typical qualification requirements | A reasonable amount of equity in your home and not too much debt. Your income and credit score will also be considered. | Acceptable credit score and history, proof of sufficient income, reasonable debt service ratios. |
Home equity loan vs personal line of credit: Which is right for you?
Here are some things to consider if you’re not sure whether to go with a home equity loan or a personal line of credit:
Home equity. Do you own a home, and if so, have you built up sufficient equity to borrow against? If not, a home equity loan isn’t an option for you.
Interest rates. Interest rates can be very high on home equity loans because lenders take on more risk. Are you willing to pay those extra charges?
Credit score. If you’re a homeowner whose score is on the lower side, you may have more luck getting a home equity loan than a personal line of credit.
Fees. Home equity loans tend to come with lots of additional fees compared to personal lines of credit. Fees include things like appraisal and legal expenses.
Risk of default. You assume more risk when you take out a home equity loan compared to a personal line of credit, because the lender can take possession of your property if you can’t make the payments.
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