Home Equity Loan Vs. Personal Loan: Which is Better for You?
Homeowners with sizeable equity in their homes can consider a home equity loan. It is considered a low-cost way to finance a home project or another major purchase. However, it’s not the only option: other alternatives like personal loans can be just as affordable.
What’s the best choice for you? We’ll show you the similarities between a home equity loan vs a personal loan and what to consider before applying for either one.
What’s the Difference Between a Home Equity Loan and a Personal Loan?
The main difference between a personal loan and a home equity loan is the type of collateral required and how you’ll get approved. Both types of loans allow you to use funds for almost any reason.
Personal loans are typically unsecured loans, meaning that you don’t need to back up your loan with collateral like your car or your home. Once your application is approved, you’ll receive a lump sum payment which you pay back over time, usually in fixed monthly payments. APR or interest rates tend to start higher than what you would pay for a home loan, but they can be lower than other rates, such as credit cards.
Your credit history and ability to pay back your loan (determined by using factors such as income and existing debts) get taken into consideration when applying for a personal loan, so the higher your score, the better rates and terms you’re likely to receive. Don’t know what your score is? Use RocketHQSM to check for free, and even learn ways to raise your score.
On the other hand, home equity loans are a type of secured loan – your home equity acts as collateral. If you can’t pay back your loan, the lender has the right to seize your home. Then the amount you qualify for is determined by a number of factors including the amount of equity you have in your home, the value of the house, your credit history and ability to pay back the loan.
Since home equity loans are secured, borrowers tend to get a lower interest rate compared with personal loans. Terms can also be much longer. Just like personal loans, you’ll receive your loan amount in a lump sum and pay it back over a set term, usually with a fixed rate.
Both personal loans and home equity loans can charge origination fees, which is what you’ll pay to process the loan. Personal loans normally process faster than home equity loans since the latter typically requires a more extensive application process.
Is it Better to Get a Home Equity Loan or Personal Loan?
In short, it depends. Both loans offer advantages and large amounts of cash, depending on your requirements and financial situation. Of course, there are risks with each choice, and they differ in terms of how to qualify.
When to Choose a Personal Loan
You want money quickly – Getting approved for a personal loan is usually faster than the approval process for a home equity loan. You can get cash in your account in as little as one business day, depending on the loan amount and the lender. Borrowers don’t have to go through demanding processes like an appraisal and other reviews as they would for a home equity loan.
You don’t want to borrow a lot of money – Generally, a personal loan is best if you want to borrow money in smaller amounts. However, if you want a higher loan amount and want a faster approval process, consider a cash out refinance.
You want an unsecured loan – Defaulting on your payments will negatively affect your credit score, but it won’t cause you to potentially lose your home.
When to Choose a Home Equity Loan
You’re interested in 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 understand you could lose your home if you don’t, then consider this option.
You want flexibility – Personal loans offer some decent payment terms and fixed terms, but they may not be as long as the ones for home equity loans – some can last as long as 30 years.
You need to borrow more money – If you want to borrow a large sum of money (more than the typical personal loan lending limit of $45,000), it could be a better idea to go the home equity loan route, especially if you have significant home equity. Plus, lower interest rates can save you thousands over the loan’s lifetime.
You want a possible tax deduction – The interest you pay could be tax deductible if you’re using loan funds to purchase, build or improve your house in a significant way. IRS rules may change, so check with a tax professional to see how significant those potential benefits can be.
What Will You Choose?
There are no hard and fast rules when deciding between a personal loan vs a home equity loan; the best choice depends on you and your unique financial situation. Before proceeding, think carefully about whether you’re willing to put up your home as collateral for a lower rate, or receive money faster but at a potentially higher rate. Also consider how much you need to borrow and whether you can afford the payments. Then make sure you shop around for the best rates. At Rocket Loans®, we let you look at your personal loan options without affecting your credit score.
Whichever option you choose, assess your credit situation so you can understand what you qualify for. RocketHQ provides free credit monitoring to help you figure out how to best navigate your situation. Ask lenders as many questions as you want to make sure you’re clear on terms and rates so you can get the best deal.
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What Credit Score Do You Need for a Personal Loan?
Wondering what credit score you need for a personal loan? Read our article for a background on good credit and the effects of credit on personal loan approval.