Personal Loan vs. Home Equity Loan: A Comprehensive Comparison

Personal loans are a type of unsecured loan that does not require any collateral, which is an item of value that serves as security for the loan and that the lender may reclaim if the borrower is unable to repay the loan. These can be used for anything from consolidating debt to spending for a wedding, renovations, medical bills, or even a significant cost item like boats or cars.

In most cases, the term period for repaying a personal loan is between one and seven years. Longer loan durations typically come with a higher interest rate. Personal loans have variable interest rates that might be anything from four percent to thirty-six percent. Also, while most lenders have a maximum loan amount of $5,000, there are a few that go as much as $100,000. Remember that your income, bills, and credit history will all play a role in determining whether or not you qualify for a loan and at what interest rate.

However, a home equity loan can be utilized as security for a loan through a home equity line of credit. The current market value of the residence is subtracted from the mortgage balance to get this figure. Lenders often want 15–20 percent equity in a home and a credit rating of 620 or higher. It is possible to borrow up to 85% of your equity, with repayment durations between 5 and 30 years.

How Does a Personal Loan Work?

Depending on the lender, the time it takes to hear back after applying for a personal loan might range from a few minutes to a week. The standard minimum credit score for borrowers to qualify with most lenders is 660, and some also have minimum yearly income requirements.

If your application is successful, the lender will deposit a single amount into your bank account. Payment in full, plus interest, is due as soon as the loan is issued, regardless of how much, if any, of the principal you actually borrow.

Origination fees and prepayment penalties on personal loans are other possibilities, however, their prevalence varies widely amongst financial institutions.

Personal Loans: Pros and Cons

Pros

• The approval process is quicker compared to that of a home equity loan.
• In the event that you fail to make your payments, the bank will not attempt to reclaim any of your belongings.
• The process is simpler for lower values. You can acquire the cash you need with minimal hassle and no unnecessary extras like an assessment when you apply for a personal loan.

Cons

• The amount that you borrow in conjunction with your credit score will determine the interest rate that will be applied to your loan.
• If you pay off the loan ahead of schedule, you may be subject to prepayment penalties from some lenders.
• When compared to home equity loans, the repayment terms are typically shorter, which can result in larger monthly payments.

When Does a Personal Loan Make Sense?

Personal loans can be a better option than home equity loans in some cases:

• You’ll save money on interest. Because credit unions often provide home equity loans with lower minimums than banks (often $10,000). In contrast, the minimum amount you can borrow with a personal loan is typically around $1,000.

• Your home is too valuable to risk. Most personal loans are unsecured, meaning that you won’t lose your home or other valuables if you default on the loan.

• Your equity is low since home equity loans may be out of the question if you don’t have a significant amount of equity in your property.

• Your credit is outstanding. So, rates on personal loans might be as low as 3 percent if you have great credit.

How Does a Home Equity Loan Work?

A home equity loan can be an option if your equity is between 15% and 20%. A home equity loan can be obtained by contacting a mortgage lender or loan broker. Closing charges and fees average between 2-5 percent of the loan amount. In some cases, the lender may forego the fee.

Since the mortgage has priority over the home equity loan, both are secured by the property. After that, you’ll get your loan in one single payment and start paying interest from day one. If you are unable to repay your loan on schedule, the lender may foreclose on your home.

Home Equity Loans: Pros and Cons

Those who have built up substantial equity in their houses are prime candidates for home equity loans. Among the many benefits:

• Flexibility. A loan for home equity normally has more accommodating terms than a traditional bank loan. Personal loans typically have shorter periods (about 5–6 years), whereas home equity loans can go on for up to 30 years.

• Decrease the current interest rate. Since the value of your house acts as collateral, the interest rate you pay on the loan will be lower than if you took out a personal loan. Spending thousands or even tens of thousands less on interest over the course of a loan’s lifetime is quite possible with a lower interest rate.

• There could be a deduction on your taxes. According to the Internal Revenue Service (IRS), the interest on a home equity loan may be tax deductible if the money is used to finance the purchase, construction, or substantial improvement of the property serving as collateral.

On the other hand, the drawbacks are:

• If a borrower defaults on their loan, their property may be taken back.
• Like closing on a property, getting your hands on the money may take some time.
• Some loan companies have prohibitively large minimum sums that may be excessive for your needs.
• The costs associated with closing a deal are usually rather high.

When Does a Home Equity Loan Make Sense?

A home equity loan could be the most suitable choice to make in certain circumstances. It  could be an option for you if:

• Your equity is really high. Home equity loans can provide access to far larger sums of money than unsecured personal loans, perhaps exceeding $500,000.

• The state of your credit is not ideal: The fact that a home equity loan is secured means that even borrowers with less-than-perfect credit histories may be able to get approved, but they should be aware that their interest rates may be higher.

• Finding affordable interest rates is a priority for you. Rates for home equity loans are often lower than those for unsecured loans, resulting in a smaller monthly payment and reduced overall cost of borrowing.

• You’re thinking of doing some house improvements. The interest you pay on a home equity loan used for improvements is tax deductible.

Alternatives to Personal and Home Equity Loans

There are alternative ways to get money besides taking out a loan against your property or taking out a personal loan.

1. Credit Card – If a borrower doesn’t require a large sum of money, he or she may want to apply for a credit card, especially if one with 0% interest is available.  Even if you can’t pay off your balance in full by the due date, the interest rate you’ll pay on a credit card is typically lower than the rate you’d pay on an unsecured loan like a personal loan or a home equity line of credit.

2. Home Equity Line of Credit (HELOC) – A HELOC can be used in the same way as a credit card. A home equity loan gives you access to a revolving line of credit that can be used for whatever you like. In addition to potentially being tax deductible, the interest paid on a HELOC is typically cheaper than that of other loan types.

3. Loans for Home Improvement – It’s important to note that home equity loans are secured loans, while home improvement loans are often unsecured personal loans. Unsecured home improvement loans may have higher interest rates than secured loans, but they are a good option for homeowners who want to make moderate improvements to their houses but don’t want to put up any collateral.

4. Cash-out Refinance – You can refinance and take out extra equity in your house if you have at least 20% of it. Paying off debt, making improvements to your current residence, or even buying another property are just some of the many possible uses for the money.

Bottom Line

Personal loans and home equity loans are two options for borrowing money, but which one is better for you will depend on your specific circumstances. There are pros and negatives to both sorts of loans that you should weigh carefully before applying for either one. Before applying for a loan, it’s important to weigh your options and make an informed decision based on the rates, fees, and terms offered by each lender.