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If you’re planning on making a large purchase, want to consolidate credit card debt or pay for a large expense such as medical bills or a home renovation, you’ll have a couple of finance options.
The most common is a personal loan, but a home equity loan may be a better option. So, here we’ll explore a home equity loan vs personal loan comparison to help you to make an informed decision.
How Do They Work?
While on the face of it, home equity loans and personal loans may seem very similar, there are actually some crucial differences. It is important to be aware of these differences.
Home Do Equity Loans Work?
Home equity loans are secured on your property as a second charge. Essentially, you can access the difference between your home’s value and your current mortgage.
For example, if your home is worth $500,000 and you have a $300,000 mortgage, you have $200,000 in equity. Most home equity loan providers will allow you to borrow up to 80% of your home value less your mortgage. So, in the above scenario, you could access $100,000 as your home equity loan.
Depending on the amount of equity that you have in your home, you could access a far higher sum than you would with a personal loan. However, it is important to note that the loan is secured on your property.
This means that a home appraisal will be part of the application process, which will increase the time frame for funding. Additionally, it means that if you fail to adhere to the repayment schedule, your home is at risk of being repossessed, so the loan issuer can recoup its losses.
Just be aware that many home equity loans have restrictions on what you can and cannot use the funds for. So, while you may be able to use the loan for home improvements or medical bills, the lender may not permit you to use them for a vacation.
How Do Personal Loans Work?
Personal loans are one of the most straightforward and popular forms of finance. Most personal loans are unsecured, which means that your rate, terms, and approval decision are based on your credit report and financial circumstances.
However, the minimum and maximum sums you can borrow will be determined by the specific policies of the bank or financial institution. In some cases, you can borrow as much as $30,000 to $50,000, but there are some lenders that will loan up to $100,000 if you meet the requirement criteria.
Personal loans tend to be popular as they have a very straightforward application process. Many financial institutions will provide an approval decision within a day or two and some will fund the loan in a similar amount of time.
This means that if you submit your application on Monday, you could have your funds in your bank account by Thursday or Friday, depending on the lender policies.
Personal loans are also available for practically any purpose. You can use the loan funds for debt consolidation, home improvements, a large purchase, or even a use a personal loan to buy a new car. In fact, the lender may not even ask the reason for you wanting a loan or be satisfied with a general answer.
What Are The Benefits Of Each Loan?
Personal Loan | Home Equity Loan |
|---|---|
Funding Speed | Lower Rates |
No Security | Larger Amounts |
Flexible Usage | Longer Terms |
Fixed Rate | Fixed or Variable Rate |
- Funding Speed
The main advantage of a personal loan over a home equity loan is the speed of funding. Since most personal loans are unsecured, you can get access to funds quite quickly.
This means that you won’t need to wait around for weeks to get your hands on the cash.
- No Security
Another implication of a loan being unsecured is that your property is not at risk if you fail to pay back your loan.
Of course, there are still financial and credit implications of late or missed payments, but you won’t need to worry about your home being foreclosed or assets seized.
- Flexible Usage
Another benefit of choosing a personal loan rather than a home equity loan is that you can use the funds for practically any purpose. In fact, you can use the funds for a variety of reasons.
For example, if you want to clear a credit card account, pay off a car loan and then take a vacation with the rest of the money, you can do this.
- Fixed Rate
Most personal loans are fixed rate, which can be highly beneficial if you want to make budgeting simple. You’ll know exactly how much you need to repay and when you need to make your payments each month.
With a fixed rate, you won’t need to worry about rising interest rates making your loan more difficult to manage.
- Lower Rates
Since the loan is secured on your home, there is far less risk for the lender. If you fail to adhere to the repayment schedule, the lender has the option to have a lien placed on your home or in a worst case scenario, seize the property to recoup its losses.
This is reflected in the rates, so you can expect to pay a far lower rate compared to an unsecured personal loan.
- Larger Amounts
The loan amount is determined not only by your financial circumstances, but also by the equity you have in your home.
This means that if you have sufficient income and lots of equity, you will be able to borrow a far larger sum than you could with a personal loan.
- Longer Terms
Since home equity loans are typically offered for higher amounts, lenders are happy to offer longer terms. While the maximum personal loan term is typically five to seven years, a home equity loan could have a term of up to 20 years or longer.
This can make your monthly repayments more manageable, but you may end up paying more interest over the lifetime of the loan.
- Fixed or Variable Rate
Home equity lenders have a variety of loan products including both fixed and variable rates. This means that if you prefer the stability of knowing exactly how much you will pay each month, you can choose a fixed rate deal.
However, if you would like to take advantage of rates dropping and paying less, you could have a variable rate deal.
When It Makes Sense to Use a Home Equity Loan
There are several scenarios where it makes sense to use a home equity loan. These include:
- You need a large sum: If you’re planning on making a large purchase, you want to pay for medical bills or you are planning home improvements, you’re likely to need a large sum that you may not be able to access with a personal loan. Providing you have sufficient income and equity, you can borrow far more.
- You don’t have great credit: Unless you have excellent or good credit, you are not likely to be able to access personal loans for good credit and enjoy the best personal loan rates. However, since home equity loans are secured on your property, they carry less risk for the lender. So, even if your credit is not perfect, you may still qualify for a very competitive deal.
- You need a longer term: If you want to take your loan out over a longer term to keep your monthly costs low, a home equity loan could be a better solution. Depending on the specific lender policies, you may be able to take your loan out over 20 years or more.
- You’re planning home improvements: If you are considering a remodel that will increase the value of your home, a home equity loan could be the best option. The increase in your property value could offset the loan costs, so that you can enjoy a nicer home without needing to move.
When Personal Loan Make Sense | When Home Equity Loan Make Sense |
|---|---|
You need quick funds | You need a large sum |
You don’t want to put your home at risk | You don’t have great credit |
You have a high credit score | You need a longer term |
You’re planning home improvements | You want fund flexibility |
When It Makes Sense to Use a Personal Loan
Likewise, there are scenarios when using a personal loan is a better option. These include:
- You need quick funds: Since a personal loan will not require a home appraisal, the application process tends to be quite quick. Depending on the lender, you may be able to have the funds in your account within a couple of days. In fact, some lenders will provide an approval decision in hours and funding within one business day. So, if you have immediate plans or there is a time-sensitive financial situation, a personal loan is a better option.
- You don’t want to put your home at risk: Personal loans are typically unsecured, which means that while there are financial and credit implications of missing payments or making late payment, you won’t be putting your home at risk.
- You have a high credit score: while you don't need a high score to get a personal loan, if your credit is high you can enjoy better rates on your loan.
- You want fund flexibility: If you want to use the loan funds for a variety of purposes, you may not appreciate the restrictions applied to home equity loans. In many cases, a personal loan lender may not even ask why you want the funds. Although it can be beneficial to let them know if you want to use the funds to pay off your credit cards or other debts on your credit report.
- You want to extensively comparison shop: Since personal loans are very common, there is the opportunity for extensive comparison shopping. You can compare loans to find the best possible deal from banks, credit unions, peer to peer lenders and other financial institutions.
4 Alternatives to Personal Loans & Home Equity Loans
If you’re unsure whether a personal loan or home equity loan is the right choice for you, there are some loan alternatives you may want to consider.
- Home Equity Lines of Credit
HELOC works in a similar way to home equity loans, but instead of receiving a lump sum, you can call down funds as and when you need them. Additionally, you’ll only start paying interest when you’ve called down the funds.
As with a home equity loan, a line of credit is secured on your property and based on your home equity. So, the application process will involve an appraisal and it can take several weeks to arrange.
However, if you’re planning on a project, such as a home renovation, you won’t need to pay interest on the funds for all stages of the project at once. You can simply call down funds for each stage of the remodel.
- 0% APR Credit Card
If you don’t need a massive sum and have the ability to repay it within a shorter period, a 0% APR credit card could be an economical way to access the funds. If you know how a 0% APR credit card work and how to use it smartly, it can be a great alternative.
There are many credit cards that offer 6,12 or 18 months at 0% APR, which means that you can spread the cost of a major purchase or pay down your debt without incurring interest charges.
- Personal Line of Credit
As an unsecured loan, a personal line of credit does not require security for approval. Similar to credit cards, the features of personal lines of credit often include a defined credit limit, an adjustable interest rate, and a set payment schedule. Most of the time, you can only get a personal line of credit if you're already a client of a particular lender.
For instance, if you don't currently have a checking or savings account with a bank, you might not be eligible for the best rates. However, if you meet the requirements, you can be given a credit limit of $1,000 to $100,000 or even more if you have a lot of assets in the bank.
FAQs
As with any loan, a hard credit inquiry will cause a drop in your credit score of a few points initially.
However, if you manage the loan responsibly, meeting your repayment schedule could actually help you to build your credit, particularly if you’ve consolidated your debts.
Yes, it is possible, but the lender will look at whether you can afford the new loan repayments in addition to meeting your financial obligations including your mortgage payments.
Typically yes. Since a home equity loan is secured, there is less risk for the lender and this is reflected in the rates.
However, if you have excellent credit you may be able to obtain a better personal loan rate compared to someone with poor credit and a home equity loan.
There are a number of banks that offer both personal loans and home equity loans including Bank of America, Chase and Wells Fargo.
There are lots of online lenders offering personal loans and home equity loans including Marcus, Ally and Axos.
