Home Equity Loan Vs. Personal Loan: A Guide To Picking The Best Option
Miranda Crace7-Minute Read
UPDATED: November 14, 2023
Homeowners with enough equity in their house can apply for a home equity loan. This kind of loan is considered a low-cost way to finance a major purchase, consolidate debt or cover an emergency expense. However, putting your house up as collateral can be risky, and personal loans can be just as affordable without requiring collateral.
Let’s take a close look at a home equity loan versus a personal loan and the factors you should consider before applying for either.
The Difference Between A Home Equity Loan And A Personal Loan
On the surface, a personal loan and a home equity loan may appear similar. Both are installment loans that allow you to use funds for almost any reason, including:
See the chart below for an at-a-glance perspective of personal loans versus home equity loans.
Home Equity Loan
You borrow against the equity in your home.
Your collateral is your home. If you stop making payments, your lender can take your home through the process of foreclosure.
Lenders will check your home equity, credit score, income and debts to determine if you qualify and your potentialinterest rate.
You pay back a home equity loan in monthly installments, with interest.
Your home equity isn’t involved. Lenders look at your credit score and debt-to-income ratio (DTI) to see if you qualify for a personal loan and determine how much they’rewilling to lend you.
Most personal loans require no collateral.
Lenders will look at your credit score, income and debts when determining whether you qualify for a personal loan and setting your potential interest rate.
You’ll pay back your personal loan in regular monthly installments that include interest.
How Do Personal Loans Work?
Personal loans are typically unsecured loans, meaning you don’t need to back up your loan with collateral like your car or your home. If you stop making payments, lenders can’t take your personal belongings since you didn’t use them as collateral. Lenders can, however, send your defaulted loan to collections, and your credit score can take a big hit.
Once your personal loan application is approved, you’ll receive a lump-sum payment that you typically pay back in fixed monthly installments. Your interest and annual percentage rate (APR) will largely depend on your credit history and ability to pay back your loan, so the higher your credit score and the lower your debt-to-income ratio, the better the rates and terms you’ll likelyreceive.
How Does A Home Equity Loan Work?
Home equity loans are a type of second mortgage, which uses your home as collateral. That means if you can’t pay back your loan, the lender can seize your home through the foreclosure process.
The amount of money you can qualify for is determined by factors such as home equity (the value of your home minus your remaining mortgage balance), your credit history and your income. For example, if you have $70,000 in equity, you might be able to qualify for a home equity loan of $60,000. But if you have a limited income or poor credit, your lender may only offer a $50,000 home equity loan.
Since a home equity loan is secured by the collateral that is your home itself, borrowers tend to get a lower interest rate than they would with an unsecured loan. A repayment term can also be much longer with a home equity loan. Just like with a personal loan, you’ll receive your loan amount in a lump sum and pay it back over a set term, usually with a fixed rate.
While both personal loans and home equity loans can come with origination fees, only home equity loans come with closing costs. This extra expense can include appraisal fees, the cost of running your credit, title insurance premiums and more.
Home Equity Vs. Personal Loan: Which Is Better?
Whether a home equity loan or a personal loan is better for you will depend mainly on your financial situation. Both loans carry certain risks and benefits, and they vary in their qualification requirements.
When To Choose A Personal Loan
Below are some reasons you might apply for a personal loan.
You Want Money Quickly
The time it takes to get a personal loan is usually faster than the approval process for a home equity loan. You can potentially get cash in your account within 1 business day, but the exact amount of time it takes will depend on the loan amount and the lender. A home equity loan is more involved, usually resulting in a longer wait for cash.
You Don’t Want To Borrow A Lot Of Money
Generally, a personal loan is best if you want to borrow $50,000 or less.
You Want An Unsecured Loan
As mentioned, most personal loans are unsecured – meaning no collateral is required. Instead, loan approval will be contingent upon your credit score, income and other financial circumstances. In a worst-case scenario, your credit score might suffer if you default on payments, but you won’t risk losing your home.
When To Choose A Home Equity Loan
Here are some reasons you might consider a home equity loan.
You Want A Lower Interest Rate
Home equity loans tend to have lower interest rates than personal loans. If you believe you can make on-time payments and are comfortable with the risk of losing your home, this loan option could be a good one for you.
You Want Long-Term Flexibility
A personal loan may offer a variety of repayment term options, but the repayment term for a home equity loan is typically longer and can be up to 30 years. If your repayment term is longer, your monthly payments may be lower with a home equity loan than a personal loan, but it depends on the size of the loan and how much you’re paying back.
You Need To Borrow More Money
Rocket Loans℠ offers personal loans ranging from $2,000 – $45,000. If you want to borrow a larger sum of money, it may be a better idea to go the home equity loan route, especially if you have significant home equity.
How To Get A Personal Loan Or Home Equity Loan
The application process for a personal loan and a home equity loan has some similarities, but each comes with its own set of requirements. You can use the following steps to apply for the loan option of your choice.
Applying For A Home Equity Loan
To get a home equity loan, you’ll most likely:
- Research multiple lenders. Before applying for a loan, consider assessing different types of lenders, such as national banks, credit unions and online lending platforms. Each can offer unique promotions and benefits.
- Get prequalified. If you’ve narrowed down your list of prospective lenders, you can get prequalified with each lender to receive a loan estimate. Then you can compare multiple loan offers to find the best rates and terms.
- Collect your documentation. When you apply for a home equity loan, be prepared to show plenty of paperwork. Your lender might ask for copies of your most recent bank account statements, pay stubs, tax returns and W-2 forms. They might also ask for your most recent credit card statements.
- Submit an application. Once you have all your documents, you can fill out and submit an application. From there, your lender will review your finances and check your FICO® Score before approving you for a home equity loan.
Applying For A Personal Loan
- Find a lender. Many lenders offer personal loans, and most have easy-to-use websites that make online research straightforward. You can also likely find reviews for a prospective lender you may want to consider.
- Compare rates and terms. Some lenders will advertise their interest rates and terms on their website. Make sure to compare a few repayment options. Consider using a loan calculator to find the best personal loan product for your situation.
- Fill out an application. This step usually requires you to provide basic information such as your name, current address and employer. Lenders might also ask for copies of your recent bank account statements and paycheck stubs so they can verify your income.
After you’ve submitted your application, your lender will usually be able to tell you in just a few hours if you’re approved for a loan, and you’ll often receive your money in 1 – 7 business days.
Rocket Loans offers same-day financing for personal loans, so the money might hit your account the same day you’re approved.1
Home Equity And Personal Loan Alternatives
It’s possible neither a home equity loan nor a personal loan will work for your situation. If that’s the case, here are some other options you could consider.
A home equity line of credit, or HELOC, works similar to a home equity loan in that you borrow against your equity and use your home as collateral. Instead of a lump sum, though, you borrow from a line of credit that you’ll pay back as you go. A HELOC includes many of the same risks as a home equity loan, including possible foreclosure.
If you want a higher loan amount with a faster approval process, perhaps consider a cash-out refinance. This method allows you to refinance your mortgage for a lower interest rate while converting your equity into cash for yourself. It’s a good way to get a loanif you’re a homeowner with some accrued equity.
0% Introductory APR Credit Card
Some credit card issuers offer a 0% APR promotional period when you sign up for a new card, giving you potentially up to 18 months of interest-free spending money. Once that period ends, though, you’ll be hit with a high interest rate for your remaining balance. Many borrowers use this type of credit card to make a balance transfer to consolidate their credit card debt.
When deciding between a personal loan and a home equity loan, the best choice always depends on your unique financial needs.
Before proceeding, think carefully about whether you’re willing to put your home up as collateral in exchange for a lower interestrate, or whether you’d rather receive money faster but likely at a higher interest rate. Also consider how much you need to borrow and whether you can afford the payments.
Think a personal loan sounds like the right option? Apply today with Rocket Loans.
1Same day funding is available for clients completing the loan process and signing the Promissory Note by 1:00 p.m. ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same day funding, but results may vary, and your bank may have rules that limit our ability to credit your account. We are not responsible for delays that may occur due to an incorrect routing number, an incorrect account number or errors of your financial institution.
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