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Home Equity Loan Vs. Personal Loan: Which Should I Choose?

Sidney Richardson9-minute read

June 14, 2021

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When you’re looking to borrow money for a home project or other expense, it can be confusing trying to find the right financing option for you. Personal loans and home equity loans are both potentially great choices, but which one is right for you and your financial needs? Let’s take a look at some of the key differences.

Rocket Mortgage® does not currently offer home equity loans.

Home Equity Loan Vs. Personal Loan: A Checklist

Whether a home equity loan or personal loan is right for you will depend on your personal financial situation. Before we get into the specifics of what each loan is better suited for, let’s take a look at some of the differences at a glance.

Goal

Home Equity Loan

Personal   Loan

I want to borrow a large amount and I’ve got the equity to cover it

My credit is shaky

I’m not in a rush

I’m confident I’ll be able to repay this loan and my mortgage without difficulty

Home values where I live are increasing

I don’t own a home or have sufficient equity

I’m planning on borrowing a relatively small amount

I need the money fast

I’m able to repay the loan quickly (36 months)

How Do Home Equity Loans Work?

So, what is a home equity loan, exactly? Sometimes called a second mortgage, a home equity loan is a loan that allows you to use the equity you’ve built in your home as collateral to borrow funds. The equity in your home is the difference between what your home is worth and what you owe on the mortgage.

You typically get the borrowed money as a lump sum, as opposed to home equity lines of credit (HELOCs) which work more like a credit card.

Since home equity loans are based on the value of your home, they won’t be an option for borrowers that might still be new homeowners. Lenders typically allow you to borrow 80-85% of your equity with a home equity loan, so if you haven’t built much equity yet, it may not be a feasible option.

If you do have enough equity to take out a home equity loan, however, they can be a good option for some. Since they’re secured, they tend to have lower rates as well.

 

Pros

 

  • Home equity loans are typically easier to qualify for than many other consumer loans.
  • Because these loans are secured by the equity in your home,  lenders consider these loans less risky and therefore charge lower interest rates than other loans.
  • The terms are longer than many other consumer loans, which makes monthly payments smaller at the cost of a substantial increase in interest paid over the life of the loan.
  • You can access the funds immediately, typically in a lump sum.
  • Monthly payments are fixed, so there isn’t much room for surprises.

 

Cons

 

  • Since your equity is held as collateral, if you are unable repay a home equity loan, you will face the prospect of, at best, a lien on your property and at worst, losing your home to foreclosure.
  • You’ll have a second mortgage to pay off on top of your primary mortgage. Two payments can become overwhelming.
  • If you sell your home, you’ll have to pay off the entire balance of the loan – as well as the remaining balance of your primary mortgage – as soon as you close, which isn’t possible for many borrowers.
  • Since this loan is often called a ‘second mortgage’ and is based on the value of your home, you’ll have to pay closing costs and potentially go through home appraisal and other mortgage processes again, unlike other consumer loans.

Great news! Rates are still low to start 2021.

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How Do Personal Loans Work?

A personal loan is similar to a home equity loan in that it is money you can borrow in a lump sum that you must repay. The difference is that home equity loans are backed by the value you’ve built in your home – whereas personal loans are often backed by nothing, making them unsecured.

Due to their unsecured nature, personal loans often have slightly higher interest rates. Whether you’re able to get a personal loan or not will depend on your income, credit score and debt-to-income ratio (DTI). Since your home isn’t involved as collateral, however, it can be a much faster process to get a personal loan than a home equity loan.

 

Pros

 

  • Personal loans are processed far more quickly than home equity loans since there is no collateral property to inspect or additional loan to consider.
  • Terms lengths are typically more flexible than home equity loans.
  • Interest rates are fixed and typically somewhere between 6-36%, depending on your credit score and other factors.
  • You don’t need to own a home or have sufficient equity.
  • Monthly payments are fixed and predictable.
  • You can access the funds immediately, sometimes on the same day as your application.

 

Cons

 

  • You must have excellent credit to qualify for a lower rate personal loan. Personal loans given to those with fair to poor credit can have outrageously high interest rates.
  • The loan terms are shorter than most home equity loans, so your monthly payments will be larger.
  • Personal loans may have higher fees and penalties for late payments and other faults.
  • Personal loans can be potentially dangerous, especially when used to pay off things like credit card debt due to their often-higher interest rates and the fact that they potentially create more debt when used to consolidate.

Which Loan Option Is Best For You?

There is no one-size-fits-all best loan for every situation – the loan that’s best for you will depend entirely on your personal financial situation. That said, let’s review some of the financial factors that might influence whether you choose to take out a home equity loan or a personal loan.

 

Choose A Home Equity Loan If...

 

Since home equity loans tend to have lower rates and lengthier terms of repayment, they can be an attractive option. If you use a home equity loan for home renovations, you might even be able to deduct the loan interest.

Remember that these loans can be risky to you since they force you to offer your home equity as collateral, but the risk does have some rewards. Here are a few reasons you might consider a home equity loan:

 

You Want To Borrow A Large Amount And You’ve Got The Equity To Cover It

 

If you want to borrow a significant amount of money for a home improvement project, for example, and you have considerable equity built into your home, a home equity loan may be the way to go. Home equity loans tend to have longer terms of repayment, which can make paying back larger amounts a bit easier than shorter-term loans. The lower interest rates that come with home equity loans can be very helpful when paying back a larger amount as well and will save you a great deal of interest.

 

Your Credit Is Shaky

 

If your credit isn’t the best but you have some equity built into your home, a home equity loan may be useful to you. While you may not be able to qualify for a great interest rate, you may still be able to borrow the funds you need with a home equity loan. Since these loans are secured, they’re seen as less of a risk to your lender and they may be more willing to part with the money.

 

If You’re Not In A Rush

 

The purpose of your loan may also have a big impact on whether you choose a home equity loan or another financing option. Since home equity loans are based on the value of your property, they require a few ‘extra steps’ that other loans don’t have, such as home appraisal and various closing costs. If you want the extra money to do renovations on your house, a home equity loan makes a lot of sense. If you need to pay urgent, emergency medical expenses, however, a home equity loan might not be such a good idea, since it can take some time to get through the origination process.

 

You Are Confident You Will Be Able To Repay This Loan 

 

When taking on a home equity loan, be sure that you are confident in your ability to repay the loan. It is a second ‘mortgage payment,’ which can be a lot. The loan also holds your property as collateral, so finding yourself unable to pay may result in your home being foreclosed upon. Before applying for a home equity loan, be sure that you can confidently cover your other loan payments and bills in addition to the new payment.

 

Home Values Where You Live Are Increasing

 

If home values are increasing where you live, you don’t have to worry much about your home equity loan. If they’re decreasing, however, know that a home equity loan may not be a good choice. There is a very real possibility that you could end up with an underwater mortgage when home values are sinking, especially if you also have a second mortgage.

Your mortgage becomes ‘underwater’ when the principal of your loan is higher than what your home is actually worth. This can make it very difficult to sell your home, especially if you are still making two loan payments on it – one of which you’ll need to completely pay off if you intend to get rid of the house.

 

Choose A Personal Loan If...

 

Personal loans may (typically) have slightly higher interest rates than home equity loans, but there are plenty of perks to them, as well. The process of getting a personal loan is significantly faster than that of a home equity loan – and you don’t need a house with built in equity to qualify for the loan.

These loans do tend to have shorter repayment terms and higher interest rates, but they can be extremely useful in a pinch, depending on your financial situation. Let’s take a look at a few reasons you might want a personal loan.

 

You Don’t Own A Home Or Have Sufficient Equity

 

While home equity loans are a great financing option for those with the equity to spare, not everyone is a homeowner. Some homeowners may be wary of offering their home as collateral, as well, or maybe don’t have enough equity built up to borrow from. Falling below a certain amount of equity on a conventional loan can come with even more costs, too, such as paying private mortgage insurance (PMI).

With a personal loan, you don’t need to own a property or make mortgage payments. You might face a higher annual percentage rate (APR) cost, but you also won’t have to deal with taking out a second mortgage or worry about having enough equity to borrow from.

 

You’re Planning On Borrowing A Relatively Small Amount

 

Applying for a home equity loan often comes with as much hassle as applying for a mortgage – meaning, it takes a while. If you’re borrowing a smaller amount of money, it may not be worth it to you to deal with the long, grueling process of home equity loan origination.

You may also save on closing costs and other fees by opting for a personal loan. Home equity loan ‘closing’ has a number of costs involved, ranging from appraisal fees to loan origination fees and title search costs. These costs often add up to 2-5% of the loan amount, which might be significant.

With a personal loan, you can skip that and save on those costs. While you may still have to pay other fees such as late payment fees or early repayment penalties, you have the ability to skip closing costs.

 

You Need The Money Fast

 

If time is of the essence, you are almost always better off getting a personal loan than a home equity loan. It can take days to a week, give or take a little, to get a personal loan – but a home equity loan might take a month or longer. If you need an ‘emergency loan’ to cover medical costs, moving expenses, or anything else urgent, it may be wise to get a personal loan; you’ll likely see the money faster. Just be sure, as always, that you are prepared to pay back what you borrow.

 

You’re Able To Repay More Quickly

 

Home equity loans typically come with terms of repayment that range from 5-30 years, whereas personal loans typically range from 1-7 years. While longer repayment terms typically mean lower interest rates and lower payments, the stretched-out payment schedule may mean you accrue more interest over time than you would if you paid off the loan quickly.

If you borrow $5000 at an interest rate of 11% and pay it off over 10 years, your monthly payment would be around $69 and you’d pay a total of $3265 in interest. If you paid that same amount, $5000, in just 36 months however, your monthly payment would be around $163.69 but you would also only pay ~$892.84 in total interest. You can potentially save thousands by paying off your loan more quickly, in some situations.

The Bottom Line: Your Home Isn’t The Only Source To Tap When You Need Cash

While having a home can give you options, there is no one-size-fits-all solution to every financing need. When choosing a loan type, make sure you consider every facet of your unique situation, including how much money you’ll need, for what and how quickly.

If you’re ready to get a loan and you’ve decided a personal loan is right for you, you can start your application with Rocket Loans® today.

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Headshot of Author Sidney Richardson

Sidney Richardson

Sidney Richardson is an intern writer covering homeownership, mortgage and lifestyle topics. She is a senior at Oakland University pursuing a degree in journalism and advertising.