Home Equity Loan vs. Personal Loan: Which To Choose?

If you need funds for home improvement projects or to consolidate high-interest debt, home equity loans and personal loans are two common financing options available. The biggest difference between the two is that personal loans are usually unsecured, while home equity loans are secured against your home.

When choosing your financing option, it’s important to understand the key differences between home equity loans vs. personal loans.

What Is a Home Equity Loan?

Home equity loans, like home equity lines of credit (HELOCs), allow you to access the difference between your home’s current market value and the outstanding balance on your mortgage. This is a secured loan and is often called a second mortgage, which means that your home serves as collateral in case you default.

The key benefit of a home equity loan is that you can get a lower interest rate compared to personal loans. The current average interest rate is 8.60% for home equity loans. However, you’ll also have to pay closing costs, which can sometimes be significant.

You can use the loan funds for large, unexpected expenses, debt consolidation, or home improvements. However, the interest paid on the loan is only tax-deductible if you use it for home improvement.

What Is a Personal Loan?

Personal loans are usually unsecured and are available at most credit unions, banks, and online lenders. They’re available in a wide variety of loan amounts, interest rates, and repayment terms, depending on your income and credit score.

Interest rates can range from 6% to 36%, depending on your creditworthiness, but the average interest rate is 12.35%.

You can use personal loans for medical expenses, emergency expenses, home renovations, or for consolidating credit card debt. These loans offer simplicity, flexibility, and predictable monthly payments.

Pros and Cons of Home Equity Loans

Home equity loans have a number of benefits, such as lower interest rates, but they also come with a few risks, as listed below.

Pros 

• Home equity loans typically have lower interest rates when compared to personal loans.
• Interest paid on the loan is tax-deductible if you use the funds for home improvement.
• You can get a higher loan amount compared to personal loans if you have enough equity.

Cons 

• You can lose your home if you fail to repay the loan.
• Additional fees, such as closing costs, can be substantial.
• You may owe more than the house is worth if the value of your home reduces.

Pros and Cons of Personal Loans

Personal loans offer a lot of flexibility but have higher interest rates than home equity loans. Consider these pros and cons before you decide to borrow.

Pros 

• Personal loan funds can be used for any purpose.
• Monthly installments are easier to budget due to fixed interest rates and predictable payments.
• These are unsecured loans, so you don’t risk losing your assets.

Cons 

• Personal loans come with higher annual percentage rates (APRs) than secured loans.
• Loan amounts may be lower than home equity loans.
• Personal loans for bad credit are available, but the borrowing costs can be very high.

Key Differences Between Home Equity Loan Vs. Personal Loan

Understanding the key differences between home equity loans vs. personal loans will allow you to make an informed decision about which option is right for your financial situation:

• Collateral: Your home will serve as collateral with a home equity loan. Personal loans are unsecured, so you don’t risk losing your assets.
• Interest Rates: Both types of loans usually have fixed rates, but home equity loan rates are typically lower.
• Loan Amounts: Most lenders typically don’t offer more than $100,000 through personal loans. However, you may be able to borrow a larger amount through a home equity loan if you have enough equity.
• Repayment Terms: Typical personal loan terms range from one to seven years. Home equity loans have longer terms of up to 30 years.
• Fees: Other than interest, you may have to pay an origination fee on a personal loan. Home equity loans come with title search and appraisal fees and other closing costs, which can be 2% to 5%.

What Are the Requirements for Home Equity Loans and Personal Loans?

When you apply for a personal loan, the lender will usually take these factors into consideration:

• Your credit report and credit score
• Your employment status and income
• Your debt-to-income ratio

The eligibility requirements for home equity loans include:

• A strong credit history of paying your bills on time
• A credit score of at least 620
• A debt-to-income ratio of no more than 50%
• A loan-to-value (LTV) ratio of no more than 85%

How To Choose Between Home Equity Loans and Personal Loans?

When trying to decide between home equity loans vs. personal loans, it helps to keep the following factors in mind to make your decision easier:

• Loan Amount: A home equity loan is a better choice for large expenses.
• Collateral: If you want an unsecured loan and don’t want to risk losing your assets, choose a personal loan.
• Interest Rate: A home equity loan is the better choice if you want the lowest possible interest rate.
• Repayment Term: A home equity loan is the right choice if you want a longer term to spread out your payments. Keep in mind that you’ll end up paying more in interest over the life of the loan.
• Funding Time: If you need money quickly, a personal loan is a better choice since many lenders offer same-day funding once your loan is approved.

How To Get a Home Equity Loan or a Personal Loan?

Applying for a personal loan is quite straightforward. The application process for a home equity loan is usually longer, but you’ll typically follow these steps to apply for both types of loans:

• Gather the necessary documents for the loan, such as pay stubs, tax returns, and personal ID.
• Shop around to find the lowest rates and prequalify with a few lenders to see what rates you qualify for.
• Once you’ve selected a lender you want to work with, you’ll need to fill out the loan application and submit your documents.
• If you’re applying for a home equity loan, you’ll need to get an appraisal done before the underwriting team makes a decision.
• Once your loan is approved, you’ll sign the loan agreement and receive the funds.

Should I Get a Home Equity Loan or a Personal Loan?

When comparing home equity loans vs. personal loans, it’s important to think about how much you need to borrow, the purpose of borrowing, and the loan terms you need. Personal loans are usually good for short-term, smaller expenses. While personal loan rates are higher than home equity loans, they don’t come with the risk of foreclosure.

Home equity loans for home improvements are a better option when you need to borrow a larger sum for a remodel and want the flexibility of a longer repayment term. Remember that a personal loan is unsecured, so the risk is lower when compared to home equity loans, which come with a risk of foreclosure if you fail to repay the loan.

As an alternative, consider a home equity sharing agreement. Unlike traditional loans, there are no monthly payments or interest, making it an attractive choice for homeowners who don’t want to take on additional debt. However, you’ll need to be comfortable sharing a percentage of your home’s future value when sold with the company providing the agreement.