Personal loans vs. home equity loans: Which should you choose?
Home equity loans have low rates, but personal loans are fast and don’t risk your property
Homeowners have numerous financing options when they need to borrow money. Personal loans and home equity loans are two popular sources of cash for home improvements, paying for college, debt consolidation, emergencies and other large expenses.
While both loan types have their pros and cons, choosing between a personal loan and a home equity loan depends on your goals, your home’s value and other factors.
- Personal loans are unsecured, and they usually have higher interest rates and a quicker approval process than home equity loans.
- Home equity loans offer lower rates and are secured by your home.
- Approval for a home equity loan may take longer since most lenders require an appraisal.
- Homeowners may be able to deduct home equity loan interest on their taxes, depending on how the home equity loan’s funds are used.
Personal loans explained
Personal loans are unsecured loans that you can use for almost any purpose. They offer fast cash without requiring an appraisal, collateral or strict underwriting requirements. Loan applications are often submitted online or over the phone with quick approvals for eligible borrowers.
These loans are repaid over a shorter term than home equity loans (typically three to seven years) and carry higher interest rates because they aren’t backed by any assets.
In many cases, you can make extra payments or repay the loan early without any penalties. However, some lenders charge origination fees, which are deducted from your loan proceeds.
Key points about personal loans
- Use of proceeds: Personal loans can be used for almost any purpose, such as emergencies, debt consolidation, vacations or home improvements.
- Common borrower profile: Borrowers typically have strong credit scores but don’t have assets or equity in their home (or don’t want to use their assets/equity as collateral).
- Loan amounts: These range from $1,000 to $100,000, but many lenders max out at $50,000.
- Terms: Most personal loan terms range from three to seven years, but this varies by lender.
- Credit score: Credit score requirements also vary by lender, but some lenders accept scores of 600 or lower. Upstart accepts credit scores as low as 300.
- Interest rate: Interest rates vary based on your credit score, loan term and the amount you borrow. Rates generally range from around 8% to 36% as of publication.
- Approval time: Some lenders offer immediate decisions, while others may take a few days to review application details manually.
» COMPARE: Best personal loan companies
Pros and cons of personal loans
Personal loans offer fast approval and flexibility but come with relatively high interest rates and lower loan amounts than home equity loans. Before applying for a personal loan, consider the pros and cons of this loan type.
- They have fast approval times. Some lenders can approve personal loan applications immediately and fund the loans the next day.
- Personal loans usually aren’t secured by collateral. They are available to people who don't own a home or other significant asset.
- They have minimal restrictions. You can use the money for a wide range of purposes.
- You may need a good credit score for approval. Lenders have stricter credit requirements for unsecured loans than secured loans.
- They can have high interest rates. Lenders typically charge higher rates for unsecured loans, and origination fees can increase the cost even more.
- Personal loan amounts are comparatively small. Most lenders offer personal loans of $50,000 maximum.
Home equity loans explained
Since they are based on the value of your home, most home equity loans require an appraisal. The appraised value determines the maximum amount you can borrow after factoring in the balance of your primary mortgage. Many homeowners choose home equity loans as a way to tap into their home's equity without refinancing their primary mortgage.
Keep in mind that home values are impacted by market forces and the general state of the economy. Some lenders stop accepting home equity loan applications when they believe that home values are at their peak and/or an economic downturn is imminent.
Key points about home equity loans
- Use of proceeds: Home equity loans are often used for home improvements, debt consolidation and other large expenses. Under current tax law, home equity loan interest is deductible only when used to buy, build or improve your home.
- Common borrower profile: Home equity loans are available to borrowers who have at least 15% to 20% equity in their homes.
- Loan amounts: Loan amounts depend on how much home equity you have and your lender's maximum loan-to-value (LTV) ratio. Most lenders allow 80% to 85% LTV.
- Terms: Most home equity loan terms are either 10 or 15 years, though some lenders may offer home equity loans with terms as short as five years and as long as 30 years.
- Credit score: Lenders typically require credit scores of at least 620.
- Interest rates: Interest rates are fixed and vary by lender. Your rate will be based on your LTV, credit score and other factors.
- Approval time: Your application can be approved within a few days, but underwriting and funding can take a few weeks.
» COMPARE: Best home equity loan lenders
Pros and cons of home equity loans
While home equity loans typically accept lower credit scores while granting you access to higher amounts of money than personal loans, they come with their own risks. Your lender could foreclose on your home if you miss too many home equity loan payments, and an outstanding home equity loan balance can complicate the process of selling a home.
Karl Jacob, CEO of mortgage lender LoanSnap, explained that a home equity loan "is a lien on your home, so you have to pay off the home equity loan as part of the process of refinancing or selling the house."
- Home equity loans tend to have low rates. Having a home as collateral allows lenders to offer lower interest rates than they can for personal loans.
- You can get a large loan amount. Depending on your equity, you can borrow up to 85% of your home’s appraised value.
- Credit scores are less critical. Since the loan is secured by your home, lenders are more willing to approve borrowers with lower credit scores.
- It puts your home at risk. If you stop making payments, the lender could foreclose on your home.
- It may take a long time to approve. The underwriting process can take several weeks before you have access to the money.
- You could owe more than your home is worth. If home values fall, your home could be worth less than the combined balances of your mortgage and home equity loan.
» MORE: How to stop foreclosure
Comparing personal loans and home equity loans
Personal loans and home equity loans have many similarities, but they also differ in important ways. Compare them carefully when deciding which loan type is best for your borrowing needs.
What personal loans and home equity loans have in common
These loan types have several features in common that make them popular choices for borrowers:
- They typically have fixed interest rates throughout the loan term.
- Their monthly payment amounts generally don't change.
- Their funds can be used for a wide range of purposes.
How personal loans and home equity loans differ
Personal loans and home equity loans diverge in a number of ways:
- Personal loans are unsecured, while home equity loans are secured by your home.
- Home equity loan interest may be tax deductible, depending on how the money is used, while personal loan interest isn’t tax deductible.
- Personal loans can be approved and funded within one business day, while it can take weeks for a home equity loan to be finalized.
- Interest rates for home equity loans tend to be lower because they are secured by your home, whereas personal loan interest rates are higher because they're unsecured.
Alternatives to personal loans and home equity loans
Personal loans and home equity loans aren't the only ways to borrow money. Other financing options may be a better fit depending on your credit score, borrowing needs and the expected time frame to repay the debt.
Credit card intro APR offers
Credit cards generally have high interest rates, but many offer 0% introductory annual percentage rates (APRs) for new accounts. These offers on balance transfers, new purchases or both allow you to avoid interest during the promotional period. Applications are often approved the same day, so you can start spending almost immediately.
Just be sure to pay your balance off before the promotion expires to avoid paying interest at the card’s regular rates.
Home equity line of credit
A home equity line of credit (HELOC) is similar to a home equity loan, as it is secured by your home's value. However, a HELOC differs from a home equity loan in that it is a revolving line of credit rather than an installment loan. You can repeatedly withdraw and repay funds from a HELOC as you would with a credit card.
A HELOC’s draw period may last for up to 10 years, and you can make interest-only payments on any funds borrowed from the HELOC during that time. Any outstanding balance following that period is amortized into principal and interest payments during the subsequent repayment period. Note that a HELOC’s interest rates are usually variable during the draw period, which can be a disadvantage in rising rate environments.
Borrowing from your company’s retirement plan offers guaranteed financing because there aren't any underwriting criteria. In accordance with federal law, companies typically let workers borrow the lesser of up to 50% of their 401(k)’s value or $50,000. If you have a 401(k) loan balance, your paycheck’s usual 401(k) contributions may go toward paying down that balance rather than being invested.
A major downside of a 401(k) loan is that the loan balance may be due immediately if you leave your job. If you don't repay it, the loan is considered a disbursement. This leads to a 10% penalty, and the balance counts as taxable income.
Is a home equity loan a refinance?
No, a home equity loan is not a refinance. A home equity loan is a second mortgage that allows homeowners to tap into their equity without changing their mortgage’s current interest rate, loan term and monthly payment. However, getting a home equity loan usually involves some of the same steps as a refinance, like an appraisal and signing loan documents in front of a notary.
Are personal loans unsecured?
Yes, most personal loans are unsecured. This makes personal loans accessible to a wide variety of borrowers, including those who either don't own a home or don’t have enough equity in their home to be eligible for a home equity loan.
Should I use a personal loan or home equity loan to pay off credit card debt?
There are many factors that will influence your choice between a personal loan and a home equity loan, including whether you own a home, how much equity you have and how quickly you'll pay the money back. Personal loans tend to be for smaller amounts and offer quick approvals. Home equity loans have lower rates but can take several weeks before money is available.
- Experian, " What’s the Largest Personal Loan I Can Get? " Accessed Sept. 10, 2023.
- Intuit, " What credit scores do I need to get a personal loan? " Accessed Sept. 10, 2023.
- The Mortgage Reports, " What’s the maximum HELOC amount? Guide to HELOC limits ." Accessed Sept. 10, 2023.
- Intuit, " Home equity loan requirements: What you need to know ." Accessed Sept. 11, 2023.
- LendEDU, " How Long Does It Take to Get a Home Equity Loan or HELOC? " Accessed Sept. 11, 2023.
- Experian, " What Happens to a 401(k) Loan if You Change Jobs? " Accessed Sept. 11, 2023.
- IRS, " Retirement Topics - Plan Loans ." Accessed Sept. 12, 2023.
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