Personal loans can be used freely and are unsecured, while home equity loans normally come with lower rates - but they use your home as collateral.
Home equity loans risk foreclosure if you are unable to pay your debts, while personal loans will affect your credit score and potentially cause other financial issues.
Beyond these two main loan types, alternatives do exist - learn more about HELOCs, credit card financing, and home improvement loans may be appropriate for your situation.
A personal loan is generally unsecured and versatile, allowing you to use it for any reason, like consolidating debts to covering unexpected costs or even a computer upgrade. In contrast, A home equity loan is tied to your home's value. The loan will normally come with potentially lower interest rates, but there is the risk of using your home as collateral. You can still use a home equity loan for debt consolidation or otherwise.
Below, we will take a look at these two options to help understand the key factors to make the right decision for you and your family. Which path you choose will depend on what best aligns with your financial plan.
Personal Loans vs. Home Equity Loans: What’s the Difference?
Finding the differences between a home equity loan vs a personal loan, especially for things like debt consolidation, can be challenging. Both have distinct features tailored to serve different purposes and unique circumstances. Here are a few comparisons for review:
|Personal Loan||Home Equity Loan|
|Loan Amount||Usually up to $50,000 or more, depending on the lender.||Up to 80% of your own equity|
|Rates||Starting from 4.60% APR||Starting from 3.50% APR|
|Term Lengths||1-7 years||5-30 years|
|Secured or Unsecured||Usually unsecured, meaning no collateral is required.||Secured; your home acts as collateral.|
|Fees||Origination fees, late fees||Origination fees, closing costs, prepayment penalties, late fees|
Weighing the benefits and drawbacks of each loan type will help you in your financial planning process. Remember these distinctions to be better equipped to make an informed decision.
When to Choose a Personal Loan
Personal loans are extremely popular due to their versatility and relatively straightforward application process. They’re a form of unsecured lending, which means they do not require collateral, such as your home in a mortgage or home equity loan or your car in an auto loan. Here are a few situations when you should choose a personal loan:
- Multiple Purposes: If you have unexpected medical bills or want to finance that dream wedding, personal loans can be used to cover any expense you would like.
- Consolidation Goals: One of the most used options for personal loans is to consolidate various high-interest debts like credit cards and streamline them into one payment. This often saves huge amounts of interest costs over the life of the loan.
- No Asset Risk: As personal loans are normally unsecured, if you default on a personal loan, there is no immediate asset at direct risk. There are other severe financial consequences to doing so, such as the negative effect on your credit score.
- Speedy Access: Personal loans can be approved within days or even hours, offering quick financing for your needs, especially if you have strong credit. Other, more complicated loans have lengthier application processes or even valuation needs from the lender.
- Varied Options: Lenders provide personal loans with a range of amounts and term lengths so you can choose the best option for your circumstances.
To decide if this is the right loan for you, use our Personal Loan Calculator to help you.
When to Choose a Home Equity Loan
Home equity loans let homeowners leverage the value they have built up in their property and borrow against it. These loans offer advantages but also come with risks. Here’s when a home equity loan might be a suitable choice:
- Hefty Expenses: Home renovations or major repairs can be quite expensive, and jobs are often quoted under the price they come in at several months later. Home equity loans are often used for substantial projects like these as they can provide the needed larger amounts all at once.
- Beneficial Interest Rates: Home equity loans often have lower interest rates compared to other loan types. This is because your home is used as collateral against the loan, lowering the risk to the lender.
- Potential Tax Deductions: Some borrowers might be able to deduct the interest from their home equity loan on their taxes. Consult a tax professional before doing so to ensure you are in line with regulations.
- Extended Repayment: Home equity loans offer extended periods for those looking for longer repayment terms, which can also make cash flow easier to manage from the lower payments.
- Capitalizing on Home Value: If you have accumulated significant equity in your home over the years, a home equity loan can help leverage that value for financial needs.
A critical note to remember is that a home equity loan uses your home as collateral. If you can’t make the repayments, you risk losing your home to the lender. Assess your financial capability and ensure you can manage the payments before committing to this type of loan. Check out our easy to use Home Equity Calculator to decide if this is the right loan for you
Pros: Personal Loans Vs. Home Equity
When trying to figure out what is better, a personal loan or home equity loan, you need to assess which one better aligns with your financial needs. Here’s a breakdown of the pros of both:
|Aspect||Personal Loans||Home Equity Loans|
|Interest Rates||Typically higher than home equity loans but can be competitive based on credit score.||Generally, it offers lower interest rates since it's backed by your home.|
|Loan Term Flexibility||It can be short-term or long-term, giving borrowers versatility.||Typically, longer terms lead to smaller monthly payments but extended repayment.|
|Application Process||Faster and simpler. It is often digital and can be approved within a day or two.||More comprehensive due to the need for home evaluations.|
|Risk||Unsecured, so no immediate asset is at risk, but defaulting affects the credit score.||Your home serves as collateral; failure to repay can result in foreclosure.|
|Loan Amounts||Generally, it offers lower amounts based on creditworthiness.||
Loan amounts can be substantial, dependent on the home's equity.
Personal loans offer quick access and flexibility, catering to various financial needs without putting up any collateral. On the other hand, home equity loans are backed by your property as collateral, and can provide larger loan amounts at lower interest rates - but come with the risk of losing your home if you default. Both have their place, but the best choice depends on your circumstances and needs.
Cons: Personal Loans Vs. Home Equity
While both personal loans and home equity loans come with their advantages, there are drawbacks to consider as well. Here’s a look at both:
|Aspect||Personal Loans||Home Equity Loans|
|Interest Rates||It can carry higher interest rates than home equity loans, especially for those with average or low credit.||While rates are generally lower, they can fluctuate based on market conditions.|
|Loan Term Flexibility||Shorter terms can mean higher monthly payments.||Longer terms result in more interest paid over the loan's lifespan.|
|Application Process||Approval may be stringent for those with weaker credit histories.||The process can be longer, requiring home appraisals and thorough documentation.|
|Risk||High-interest rates can become burdensome if not managed well.||Risk of foreclosure if you're unable to meet your repayment obligations.|
|Loan Amounts||It may not cover extensive expenses due to lower offered amounts.||You're borrowing against your home, which might limit your future financial options|
There is plenty of difference between a home equity loan and a personal loan. Personal loans are flexible and often quick to secure, but they may come with higher interest rates and could pose challenges for those with less-than-stellar credit scores. Meanwhile, home equity loans offer attractive rates, but they tie you down with your home’s equity as collateral and a potential foreclosure down the road if you are unable to repay. Recognize the pitfalls to assess which risks you’re willing to take.
Alternative Borrowing Options
When trying to find what is better, a personal loan or a home equity loan, it is also smart to take a look at the alternative borrowing options. Here are a few of the more common options available.
- HELOC (Home Equity Line of Credit): A HELOC operates like a credit card, but it uses your home’s equity as collateral. It allows you to borrow up to a certain amount over a set period, using your home’s equity as collateral. Interest is only paid on the amount used, and many often allow interest-only payments. The flexibility can be useful, but remember, like home equity loans, your home is at stake if you default.
- Credit Cards: Credit cards are an option for smaller expenses or short-term needs. They provide the convenience of immediate access to funds. However, they come with steep interest rates, especially if you maintain a balance on them, and can quickly lead to accumulating debt if not managed wisely. Be careful using this option for any sort of longer-term financing.
- Home Improvement Loans: Tailored specifically for home renovations, these loans can be both secured or unsecured. They generally offer fixed interest rates and are good for homeowners wanting to increase their property value without tapping into their home equity.
When looking for a loan, it is smart to explore all of your options. Each will have its positives but also unique risks, so do your due diligence beforehand.
Figuring out whether to use a personal or home equity loan can be frustrating when you do not have the right information about both. While each has its advantages, your individual needs, creditworthiness, and financial objectives will guide you to the best decision for yourself. Remember to explore all options, weigh the pros and cons, and do your research before entering into any contract for a loan.
Is it better to borrow from the bank or use home equity?
It depends on your needs. Borrowing from a bank via a personal loan offers quick access without using your home as collateral. However, a home equity loan may offer lower interest rates - but your home is secured against the loan.
Why is equity better than a loan?
Better is subjective here. Equity represents ownership and can be leveraged to obtain loans with potentially lower rates, but loans provide immediate cash, albeit at higher rates. It really depends on your needs.
What is the major disadvantage of a home equity loan?
The major disadvantage to a home equity loan is the risk of losing your home if you default since it is used as collateral. Be financially prepared for the commitment before considering this option.