Home Equity Loan Vs. Personal Loan: What’s The Best Option?

If you’re looking to borrow money for a home renovation, project or other expense, finding the right financing option for you can present some challenges. Personal loans and home equity loans are both potentially great choices, but which one is best for your situation and financial needs?

Let’s take a look at some of the key differences between home equity loans and personal loans.

Whether a home equity loan or personal loan is most suitable for you will depend on your personal financial situation. Before we take a deeper dive into the specifics of each loan, let’s take a quick look at some of their differences.

So, what exactly is a home equity loan? Sometimes called a second mortgage, a home equity loan 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 largely on how much of your home’s principal balance you’ve paid down, these loans won’t be an option for borrowers who might still be new homeowners. Lenders typically allow you to borrow 80% – 85% of your equity with a home equity loan.

If you have enough equity, a home equity loan can be a good option. Since these loans are secured, they tend to have lower rates as well.

Home Equity Loan Pros

• Home equity loans are typically easier to qualify for than many other consumer loans.
• These loans are secured by the equity in your home, so lenders consider these loans less risky and therefore charge lower interest rates than they do on some other loans.
• The terms are longer than many other consumer loans, making monthly payments smaller at the cost of a substantial increase in interest you’ll ultimately pay by the time the loan is repaid in full.
• You can access the funds immediately, typically in a lump sum.
• Monthly payments are fixed, so surprises are rare.

Home Equity Loan Cons

• If you are unable to repay a home equity loan, you’ll face the prospect of, at best, a lien on your property and, at worst, losing your home to foreclosure. This is because your equity is held as collateral by the lender of the home equity loan.
• 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. This 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 pay closing costs and potentially have to get a home appraisal and go through other mortgage processes again.

A personal loan is similar to a home equity loan in that it’s 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.

By virtue of being unsecured, personal loans often have slightly higher interest rates. Whether you’re able to get a personal loan will largely depend on your income, credit score and debt-to-income ratio (DTI). Since your home isn’t treated as collateral with this type of loan, however, the loan approval process can take far less time than a home equity loan.

Personal Loan Pros

• Personal loans are generally processed far more quickly than home equity loans since there’s no collateral property to inspect or additional loan to consider.
• Personal loan term lengths are typically more flexible than with home equity loans.
• Interest rates are fixed and typically somewhere in the 6% – 36% range, 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.

Personal Loan Cons

• You must have excellent credit to qualify for a lower-rate personal loan. Personal loans given to those with fair or poor credit can have substantially increased interest rates.
• The loan terms are shorter than most home equity loans, which means 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 items like credit card debt – due to their often higher interest rates and their tendency to create more debt when consolidating debt.

There’s no one-size-fits-all best loan for every situation. That said, let’s review some of the financial factors that might influence whether you choose a home equity loan or a personal loan.

Choosing A Home Equity Loan

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 since they force you to offer your home equity as collateral, but the risk comes with some potential rewards. Here are a few reasons you might consider a home equity loan:

• You want to borrow a large amount and you have 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, a home equity loan may be useful. 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, who may be more willing to part with the money.

• 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.

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 quickly pay for emergency medical expenses, however, a home equity loan might not be such a good idea, since the origination process can take some time.

• You are confident you can repay the loan. Be sure that you are confident in your ability to repay a home equity loan. It’s a second mortgage payment, which can be a lot to take on. The loan also holds your property as collateral, so failure to pay may result in your home being foreclosed on.

Before applying for a home equity loan, be sure you can confidently cover your other loan payments and bills in addition to the new payment.

• Home values where you live are rising. If home values near you are on the rise, you don’t have to worry much about your home equity loan. If these values are decreasing, however, a home equity loan may not be a good choice. There’s a very real possibility 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 balance of your loan is higher than your home is worth. This can make it very difficult to sell your home, especially if you’re still making two loan payments – one of which you’ll need to completely pay off if you intend to get rid of the house.

Choosing A Personal Loan

Personal loans may typically have slightly higher interest rates than home equity loans, but they also come with perks. The process of getting a personal loan is significantly faster than the process of getting a home equity loan – and you don’t need a house with built-in equity to qualify for the loan.

These loans 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 they don’t have enough equity to borrow from.

Falling below a certain amount of equity on a conventional loan can come with even more costs, such as 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 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 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 loans have a number of costs involved, from appraisal fees to loan origination fees to title search costs. These costs often add up to 2% – 5% of the loan amount, which might be significant. With a personal loan, you’ll have no closing costs. While you may have to pay late-payment fees or early-repayment penalties, closing costs aren’t part of the equation.

• You need the money fast. If time is of the essence, you’re 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 particularly urgent, it may be wise to get a personal loan since you’ll likely see the money faster. Just be sure, as always, that you’re prepared to pay back what you borrow.

• You’re able to repay more quickly. Home equity loans typically come with repayment terms of 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 will mean you accrue more interest over time than if you paid off the loan more quickly.

If you borrow $5,000 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 $3,265 in interest. If you paid that same amount – $5,000 – in just 36 months, however, your monthly payment would be around $163.69 but you’d also only pay roughly $892.84 in interest. You can potentially save thousands by taking less time to pay off your loan.

Below are a few commonly asked questions about home equity loans and personal loans.

What’s the difference between a home equity loan and a personal loan?

The main difference between a home equity loan and a personal loan is that a personal loan is an unsecured loan, backed by nothing. A home equity loan is backed by the equity you’ve built in your home.

Is a home equity loan the same as a HELOC?

A home equity loan and a HELOC aren’t the same. With a home equity loan, you receive the full loan amount at one time. With a HELOC, you have a revolving line of credit that you can pull from at will.

Can I take out multiple personal loans or home equity loans?

There’s not necessarily a limit on how many loans you can take out, but you might be limited in the amount you can borrow. Some lenders may not allow you to have multiple outstanding loans.

While having a home can give you options, every person’s circumstances are different. When choosing a loan type, make sure to consider every facet of your unique financial 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 home equity loan is right for you, you can start the process with Rocket Mortgage® today.