If you want to borrow money to consolidate credit card debt or pay for a home renovation project, personal loans and home equity loans are two types of installment loans you could consider. Here, we compare home equity loans and personal loans to help you decide which one might be right for you.
What’s the Difference Between Home Equity Loans and Personal Loans?
While exact loan terms and requirements can vary from one lender to the next, here are some general differences between home equity loans and personal loans.
|Personal Loan||Home Equity Loan|
|Collateral||No collateral may be necessary||Your home is the collateral|
|Interest rate||Fixed rate||Fixed rate|
|Upfront fees||Origination fees may be charged||Closing costs may charged|
|Loan amounts||$1,000 to $100,000||Up to 85% of the equity you have in the home|
|Repayment terms||1 to 7 years||5 to 30 years|
|Tax perks||None for personal expenses||Interest may be tax-deductible if you use the loan to improve your home|
|Risk||Defaulting could have a negative effect on your credit||Defaulting could put you at risk of foreclosure|
One of the main differences between personal loans and home equity loans is the collateral backing. A home equity loan, often called a second mortgage, is a way to borrow a lump sum from your home equity. Since the collateral backing takes some of the risk away from the lender, you may be able to qualify for a home equity loan with less-than-perfect credit.
Personal loans are usually unsecured. This means they don’t require collateral backing. Instead, your signature on the contract is enough to get approved and receive funding. Good credit may be necessary to qualify for a personal loan, especially one with a competitive rate.
Some lenders will let you apply for a personal loan with a co-signer, and doing so could improve your approval odds and help you qualify for a better rate. If you don’t have access to a co-signer, you could also try shopping with lenders that accept fair credit.
Interest rates for personal loans and home equity loans are often fixed, so you don’t have to worry about rate hikes or payment fluctuations. The exact interest rate you’ll receive on each type of loan will depend on factors such as your credit. However, interest rates on home equity loans may be lower than personal loans because those loans are backed by real estate.
Personal loans can have an origination fee that’s a percentage of your loan. Fees vary from lender to lender, and often from loan to loan. One may charge an origination fee up to 4.75% for its loans while another charges up to 8%.
A home equity loan isn’t free, either; you may encounter closing costs such as application fees, origination fees, credit-check fees, appraisal fees, and more.
Closing costs on a home equity loan or refinance vary, but you can expect to pay 2%-5% of the amount borrowed.
Generally, lenders will offer up to 85% of your home equity in a home equity loan. The minimum you can borrow may also be high—at least $35,000, for example.
To calculate home equity, subtract your home’s market value by your loan balance. For example, if your home is worth $400,000 and your home loan balance is $350,000, your home equity would be $50,000, and a lender may let you borrow 85% of this, or $42,500.
The minimum and maximum you can borrow for a personal loan varies from one lender to the next. You may be able to borrow as little as $1,000, and it’s common for lenders to provide maximum loans of $40,000 or $50,000. However, in some cases, you may be able to borrow up to $100,000.
Personal loan terms often range from 24 to 84 months. Home equity loan terms can last from five to 30 years, which could give you a more extended period to pay off the debt.
If you use a home equity loan to build or improve your home, the interest you pay on the loan may qualify for a tax deduction. Interest you pay on a personal loan for personal expenses is generally not tax-deductible.
Defaulting on a personal loan can hurt your credit if it’s reported to the credit bureaus. Missing payments on a home equity loan could have harsher consequences: Your lender could choose to foreclose on your home because of nonpayment.
Which Is Right For You?
A personal loan will likely be the better option if you don’t own a home or don’t have enough equity to qualify for a home equity loan. It may also be a better option if you need a small loan, since personal-loan lenders may let you borrow a smaller sum.
On the other hand, if you own a home, you need a large loan, and you’re confident that you can make monthly loan payments, a home equity loan could be an affordable way to borrow money for a major purchase or debt consolidation.
No matter which option you choose, it’s important to shop around, review loan costs, and negotiate with lenders because this can help you find the best offer. A personal loan calculator can help you estimate payments based on the loan terms, interest rate, and amount you borrow.
The Bottom Line
Personal loans and home equity loans are both installment loans but how they work differ in many ways. Home equity loans are backed by your home while unsecured personal loans are not. Home equity loans may come with many different closing costs, while personal loans may have only one origination fee.
When deciding between the two options, consider how much you need to borrow, how much equity you have in your home, and how much it’ll cost you. Ultimately, the loan type that aligns with your goals the most while costing you the least is likely the better option.
Frequently Asked Questions (FAQs)
How do you get a personal loan?
You can apply for a personal loan with online and traditional lenders. The application process typically involves answering questions about yourself and your finances. Afterward, the lender does a credit check. If approved, you sign off on the loan terms, and funds may be directly deposited into your bank account.
What is the benefit of obtaining a personal loan?
Personal loans are installment loans that usually offer a set repayment schedule. If you keep up with payments each month, you know exactly when your loan will be paid off. This could be a better way to borrow money than relying on credit cards. Credit cards may come with a higher interest rate, and making just minimum payments could cause debt to spiral out of control.
How does a home equity loan work?
A home equity loan lets you borrow a lump sum from the equity you’ve built up in your house. Lenders review your income, credit, and home’s value to determine how much you qualify for. If approved, the lender funds your loan and you make payments until the loan is paid off.
How much can you borrow with a home equity loan?
You may be able to borrow up to 85% of the equity you have in your home. But factors such as your credit score, the home’s value, and your income may be considered when determining how much you can borrow.