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 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?

The main difference is that home equity loans are backed by the equity you’ve built in your home, whereas personal loans aren’t backed by any assets– making them unsecured.

Let’s look at some key differences between home equity loans and personal loans.

Personal loan vs. home equity loan: The main differences

Whether a home equity loan or personal loan is more 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, with most recent numbers as of June 2024.

How do home equity loans work?

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 a home equity line of credit (HELOC), which works more like a credit card. (Rocket Mortgage® doesn’t offer HELOCs at this time.)

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. You may be allowed to borrow up to 90% of your home’s value – depending on the lender and the strength of your application.

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

Home equity loan pros

• Easier qualifications: Home equity loans are typically easier to qualify for than many other consumer loans.
• Lower rates: These loans are secured by the equity in your home, so lenders consider them less risky and, for that reason, charge lower interest rates than they do on some other loans.
• Lower monthly payments: The terms are longer than those of many other consumer loans, making monthly payments smaller. However, you’ll ultimately pay more in interest when the loan is repaid.
• Quick access: You can access the funds immediately, typically in a lump sum.

Home equity loan cons

• Collateral consequences: If you’re 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.
• Two mortgage payments: You’ll have a second mortgage to pay off on top of your primary mortgage. Two payments can become overwhelming.
• Selling costs: If you sell your home, you’ll have to pay off the entire balance of the loan – and the remaining balance of your primary mortgage – as soon as you close. This isn’t possible for many borrowers.
• Additional costs: Since this loan is a second mortgage and is based on the value of your home, you’ll pay closing costs and potentially get a home appraisal and go through other mortgage processes again.

How do personal loans work?

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 equity you’ve built in your home, whereas personal loans are often backed by nothing – making them unsecured.

Personal loans often have higher interest rates due to being unsecured. 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 with a home equity loan.

Personal loan pros

• Quick process: 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.
• Flexible loan terms: Personal loan term lengths are typically more flexible than with home equity loans.
• Fixed rates: Interest rates are fixed and will depend on your credit score and other factors.
• Fast funding: You can access the funds immediately, sometimes on the same day you apply.

Personal loan cons

• Strict credit requirements: You must have strong credit to qualify for a lower-rate personal loan. Personal loans given to those with fair or poor credit can have substantially higher interest rates.
• Higher monthly payments: The loan terms are shorter compared with most home equity loan terms, which means your monthly payments will be larger.
• Higher fees: Personal loans may have higher fees and penalties for late payments and other faults.
• Increased debt: Personal loans can be potentially risky, due to their often higher interest rates and tendency to create more debt when consolidating debt.

Personal loan or home equity loan: Which option is better for you?

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 remodels or renovations, you might even be able to deduct the loan interest.

Here are a few reasons you might consider a home equity loan:

You want to borrow a large amount

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 when compared with shorter-term loans. The lower interest rates that home equity loans offer can be very helpful when paying back a larger amount as well and will save you a great deal of interest.

Your credit isn’t ideal

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’re able to repay the loan

Ensure that you’re 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.

Your home value is rising

If home values near you are on the rise, you may have less to worry about in taking out a 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.

Let’s take a look at a few reasons why you might want a personal loan.

You Don’t have sufficient equity

While home equity loans are a great financing option for those with the equity to spare, not everyone is a homeowner. And some homeowners may be wary of offering their home as collateral, 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 borrowing a small amount

Applying for a home equity loan often comes with as much hassle as applying for a mortgage – meaning, it may take a while. If you’re borrowing a smaller amount of money, the long process of home equity loan origination may not be worth it. 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 may have to pay late-payment fees or early-repayment penalties, but you won’t face closing costs.

You need the money now

If time is of the essence, you’re almost always better off getting a personal loan rather than a home equity loan. It can take a few days to around a week 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.

With personal loans, you’re able to repay them 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 can sometimes mean lower interest rates and lower payments, the stretched-out payment schedule will mean you’ll owe more interest over time than if you paid off the loan more quickly.

Home equity vs. personal loan FAQs

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.

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

Technically, there’s no 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.

Should I get a home equity loan or a personal loan?

Choosing between a home equity loan or a personal loan is a decision based on many personal and financial factors. If you have a significant amount of equity in your home, then a home equity loan might be right for you. On the other hand, if you’re looking to borrow a small amount of money fairly soon, a personal loan might work best for you.

How do home equity loans work?

Sometimes called a second mortgage, a home equity loan allows you to use your home equity 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 may be allowed to borrow up to 90% of your home’s value, depending on the lender and the strength of your application.

Since home equity loans are based largely on how much of your home’s principal balance you’ve paid down, it might not be a good option for new homeowners. However, if you have enough equity, a home equity loan can be a good option. Since these loans are secured, they tend to have lower interest rates as well.

Home equity loan pros

• Easier to qualify: Home equity loans are typically easier to qualify for than many other consumer loans.
• Lower rates: These loans are secured by the equity in your home, so lenders consider them less risky and, for that reason, charge lower interest rates than they do on some other loans.
• More affordable monthly payments: The terms are longer than those of many other consumer loans, making monthly payments smaller. However, you’ll ultimately pay more in interest when the loan is repaid.
• Quick access: You can access the funds immediately, typically in a lump sum.

Home equity loan cons

• Risk losing collateral: If you’re 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.
• Two mortgage payments: You’ll have a second mortgage to pay off on top of your primary mortgage. Two payments can become overwhelming.
• Selling costs: If you sell your home, you’ll have to pay off the entire balance of the loan – and the remaining balance of your primary mortgage – as soon as you close. This isn’t possible for many borrowers.
• Additional loan costs: Since this loan is a second mortgage and is based on the value of your home, you’ll pay closing costs and potentially get a home appraisal and go through other mortgage processes again.

How do personal loans work?

A personal loan is money you can borrow in a lump sum that you pay back in installments.

Personal loans often have higher interest rates because they’re typically not tied to collateral, or are unsecured loans. Whether you’re able to get a personal loan will largely depend on your income, credit score and debt-to-income ratio. The loan approval process can take far less time than with a home equity loan.

Personal loan pros

• Quicker application process: 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.
• Flexible loan terms: Personal loan term lengths are typically more flexible than with home equity loans.
• Fixed rates: Interest rates are typically fixed, which means more predictable monthly payment amounts.
• Fast funding: You can access the funds immediately, sometimes on the same day you apply.

Personal loan cons

• Strict credit requirements: You must have strong credit to qualify for a lower-rate personal loan. Personal loans given to those with fair or poor credit can have substantially higher interest rates.
• Higher monthly payments: The loan terms are shorter compared to most home equity loan terms, which means your monthly payments will be larger.
• Higher fees: Personal loans may have higher fees and penalties for late payments and other faults.
• Increased debt: Personal loans can be potentially risky, due to their often higher interest rates and tendency to create more debt when consolidating debt.

Personal loan or home equity loan: Which option is better for you?

There’s no one-size-fits-all best loan for every situation. 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 remodels or renovations, you might even be able to deduct the loan interest.

Here are a few reasons you might consider a home equity loan:

You want to borrow a large amount

If you want to borrow a significant amount of money for a home improvement project 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 when compared with shorter-term loans. The lower interest rates that home equity loans offer can be very helpful when paying back a larger amount as well and will save you a great deal of interest.

Your credit isn’t ideal

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 based on the amount of equity you have.

Since these loans are secured, they’re seen as less of a risk to your lender, who may be more willing to approve you for a loan.

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. Getting approved for a home equity loan may require a few extra steps that other loans don’t.

Since the origination process can take some time, home equity loan might not be a good idea if you need to quickly pay for emergency medical expenses. However, if you want the extra money to do renovations on your house, a home equity loan makes a lot of sense

You’re able to repay the loan

Ensure that you’re confident in your ability to repay a home equity loan. You’re taking on an additional loan and you agreed to put up 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.

Your home value is rising

If home values near you are on the rise, you may be able to tap into more equity. However, a home equity loan may not be a good choice if home values are falling. There’s a very real possibility you could end up with an underwater mortgage when home values are sinking, especially if you have a second mortgage.

Your mortgage becomes “underwater” when the principal balance of your loan is higher than what 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 sell your house.

Choosing a personal loan

Personal loans may typically have slightly higher interest rates than home equity loans, but there are some benefits. 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.

Let’s take a look at a few reasons you might want a personal loan.

You don’t have sufficient equity

Some homeowners may be wary of offering their home as collateral, 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, though you might face a higher annual percentage rate (APR).

You’re borrowing a small amount

Applying for a home equity loan often comes with as much hassle as applying for a mortgage. If you’re borrowing a smaller amount of money, the long process of home equity loan origination may not be worth it. 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. With a personal loan, you may have to pay late-payment fees or early-repayment penalties.

You need the money now

If time is of the essence, you’re almost always better off getting a personal loan rather than a home equity loan. It can take a few days to around a week to get a personal loan – but a home equity loan might take a month or longer.

What are other financing options?

Aside from home equity loans and personal loans, there are other financing options to consider:

• Cash-out refinancing: This type of loan is where you take out a new mortgage with a larger loan balance and pay off your existing mortgage. The difference you’ll receive in cash, which you can use for almost any purpose. While it does increase your monthly payment, you only have one loan to worry about.
• Home equity line of credit (HELOC): A HELOC is similar to a home equity loan in that you can tap into your home equity. Instead of getting a lump sum, you’re approved up to a credit limit, much like a credit card. You can typically borrow as often as you need during the draw period up to the limit. As you pay down the balance, you can keep borrowing more until the end of the draw period. Then, when you’ll need to pay back the remaining balance plus any interest charges during what’s called the repayment period.

The bottom line: Home equity loans and personal loans work differently

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, what you’ll need it for 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.