Home Equity Loan vs. Personal Loan
Most people consider a personal loan when they have a noteworthy expense they need to cover, but there are other options as well. A home equity loan is another way to access substantial amounts of funds. In this article, we’ll go through all the details comparing a home equity loan vs. personal loan to help you determine which option will better suit your situation.
What We’ll Cover
- What is a home equity loan vs. personal loan?
- Key differences
- Pros and cons of a home equity loan vs. personal loan
- How to apply (with checklist)
- FAQ
What is a Home Equity Loan vs. Personal Loan?
Both of these products are appealing for their wide variety of applications and are most often chosen to tackle larger projects or purchases. They can be used to consolidate debt, finance a home renovation, or even to help cover surprise expenses. Both types can be furnished by banks or alternative online lenders.
The main difference is that a personal loan is typically unsecured, whereas a home equity loan relies on your property as collateral.
Both types are taken as a lump sum and are repaid on a monthly basis. They also have fixed rates and repayment terms.
Before we go into all of the benefits and drawbacks of these products, we’ll outline the other key differences between them.
Key Differences
| Home Equity Loan | Personal Loan | |
|---|---|---|
| Terms | 5-30 year repayment | 2-7 year repayment |
| Limits | Amounts vary, not more than 85% of the equity your home | Amounts range from $5,000-$50,000+ |
| Interest Rates | 5.82% average 15-year fixed interest rate | 9.41% average interest rate |
Most personal products range from two to seven years. By contrast, a home equity loan can have the same terms as the borrower’s remaining mortgage and is usually at least five years. It can be taken at the initial closing or added on later, but must be repaid at the same time or prior to the mortgage’s maturity.
The rule for a home equity loan is that you can’t borrow against more than 85% of the equity and most often less than that. As an example, if you owe $150,000 on a home worth $250,000, you’ll be able to qualify for a loan in the $50,000 range as long as you have good credit and meet other qualifying factors. Depending on the equity you have, you may be able to qualify for much more than you would with a personal loan.
As personal loans are unsecured, the amount will be more reliant on your credit eligibility. You can get amounts as low as $1,000 and up to $100,000, but most personal products fall in between.
Secured products will have a better interest rate than those that are unsecured. Even if you have a solid credit score, a home equity option will offer a better interest rate because it is backed by the property.
Now that we’ve gone through the similarities and key differences between these products, we’ll outline the pros and cons of each to help you decide which option is best for your situation.
Pros and Cons of a Home Equity Loan vs. Personal Loan
For those looking to leverage their property value, a home equity loan will offer better interest rates, longer terms, and even larger limits than other types of loans. The biggest drawback is the risk associated with default and the home potentially losing value once you’re locked into a substantial amount and term.
| Home Equity Loan | |
|---|---|
| Pros | Cons |
| Large limits for qualifying borrowers with equity | Those with little or no equity will not be able to qualify |
| Long repayment terms which can mirror the length of the mortgage | Tapping too much equity can put you upside down if home values decline |
| Interest rates are fixed and are currently extremely low | You face foreclosure if you default |
Everyone wants a better interest rate, but if you’re planning on a smaller amount and shorter repayment term, a personal loan may be a good choice. They can also be an option if you do not have enough equity in your home to qualify for a home equity loan, but shop around to get the best interest rate and avoid fees wherever possible.
| Personal Loan | |
|---|---|
| Pros | Cons |
| Quick access to funds with a wide range of limits | Higher rates especially for those with poor credit |
| Good range of repayment terms up to seven years | May have prohibitive fees |
| Open-ended uses without the disadvantages of variable-rate credit cards | Locked into a fixed rate with no min-payment option |
Use a calculator to see how much you may be able to borrow. Once you’ve done that, compare rates between different products with reputable lenders and pre-qualify.
How to Apply
Once you’ve decided which product is best for you, it’s time to apply. Here is what you will need for both.
Application Checklist
- Government ID
- Proof of residence
- Credit score
- Employment info
- W-2 (or 1099 form if self-employed)
- Pay stubs
- Bank statements
- Proof of employment
- Cosigner info (if applicable)
- Estimated home value (for home equity loan)
NOTE: once you apply for a home equity loan, the lender will need to set up an appraisal of your property to determine its value.
As you weigh your options, here are some frequently asked questions so you can choose with confidence.
FAQ
Q: What’s the difference between a home equity loan and a home equity line of credit (HELOC)?
A: A home equity loan is paid out as a lump sum at a fixed interest rate. A HELOC is more like a credit card, in that you can borrow up to a certain limit as needed. A HELOC may be advantageous when compared to certain credit cards due to interest rates and terms, but can get some people into trouble. Remember, your house is used as collateral for both.
Q: Is a home equity loan a second mortgage or more like a refinance?
A: A home equity loan, unlike a refinance, is completely separate from your mortgage, but must be paid off prior to or at the same time your property is repaid.
Q: I don’t have enough equity in my home, and my credit isn’t great, how do I get a better rate on a personal loan?
A: Working to improve your credit over time or using a cosigner will significantly improve your ability to get approved. For more info on that, refer to our guide.
Summary
Both of these products can help you address substantial expenses much better than using a high-interest credit card or when equal payments aren’t an option. If you’re unable to qualify for a home equity loan, a personal loan still offers many unique and flexible benefits. Assess the risks and benefits to determine which best suits your financial goals.