Home equity loan vs. personal loan: which is the best option?

If you need funds for a major purchase, there are many different lending options available. Two of the most used are personal loans and home equity loans. Whether you’re thinking of consolidating debt, making home improvements, or another big expense, both loan types can be a path forward. Understanding the key distinctions between these two borrowing options will help you weigh which one best meets your goals.

This guide breaks down how each loan works, helps you determine which fits your situation, and walks you through the application process.

Home equity loan vs. personal loan: How they differ

Both personal loans and home equity loans are installment loans that allow you to use funds for almost any reason, including:

• Updating a living space
• Debt consolidation
• Emergency costs
• Medical expenses
• Large expenses or purchases

Take a closer look at this chart for more details on personal loans vs. home equity loans.

How personal loans work

Most personal loans are unsecured loans, which means that you don’t need to pledge collateral, which is required for a secured loan. If you default on an unsecured loan, you don't risk losing a possession like a home, car, or investment account. However, defaulting on a personal loan will negatively impact your creditworthiness.

When you are approved for a personal loan, you may receive your funds as quickly as the same day. This will come in a lump sum that you’ll need to repay in monthly installments.

When approving a personal loan, your lender will carefully assess your creditworthiness, credit score, and debt-to-income (DTI) ratio. These same factors also affect the annual percentage rate (APR), the total cost for borrowing money, that will be charged.

“You typically pay back a personal loan in fixed monthly installments over 2 to 7 years. Qualifying is straightforward. Lenders usually want a credit score of at least 650, though some will go lower. They want to ensure you can handle the payments,” says personal finance expert Andrew Lokenauth. “Approval can happen in 24 to 48 hours with online lenders.”

How home equity loans work

A home equity loan is a secured loan that uses the value you have in your home (your equity) to back the loan. That means if you default on your loan, the lender can foreclose on your property to repay your debt.

The amount of money you can borrow with a home equity loan will depend on your home’s loan-to-value ratio (LTV). Put another way, you’ll need to have accrued sufficient equity in your home to secure a home equity loan. The good news is that most lenders allow homeowners to borrow up to 80% (sometimes higher) of the LTV of their home.

As mentioned, your lender will also evaluate your creditworthiness and DTI ratio when considering you for a home equity loan. If you have a higher credit score, you could receive a lower interest rate and better loan terms.

“Qualifying (for a home equity loan) is more involved than for personal loans. You typically need a credit score of 620 or higher, proof of income, and a home appraisal,” says Lokenauth. “Expect the process to take between 30 and 45 days between application and funding.”

Overall, the interest rate charged for a home equity loan is often lower than for a personal loan. That's because the risk to the lender is decreased, since your home serves as collateral.

Home equity loans, like personal loans, can charge an origination fee, which will vary from lender to lender, as well as closing costs, which could include a home appraisal fee, title insurance premiums, and other fees. And with both types of loans, the funds are paid out in a lump sum.

Pros and cons of home equity and personal loans

Both personal and home equity loans carry certain risks and rewards. You can review the following benefits and drawbacks of each option before choosing which loan you want to pursue.

Home equity loans

Here's a breakdown of home equity loan pluses and minuses:

Some risks you’ll face specifically when using a home equity loan for debt consolidation include building up more debt and seeing a decrease in home value that leaves you with negative equity.

Personal loans

The advantages and disadvantages of personal loans include:

When to choose a home equity loan or personal loan

The right loan for you will depend on your needs and unique financial situation. Let’s take a closer look at scenarios when a personal loan is best and when a home equity loan is preferred.

When to choose a personal loan

A personal loan is often the better financial option when:

1. You need money fast. The approval and funding process may be faster for a personal loan than a home equity loan. Some lenders may even offer funding the same day¹ you are approved for the loan.
2. You have a lower borrowing need. Personal loans could be the ideal option if you don’t need a lot of cash. Rocket Loans offers personal loans that let you borrow between $2,000 and $45,000.
3. You prefer an unsecured loan. Most personal loans do not require collateral, which could involve less risk. But the downside is that the credit score and DTI ratio requirements may be more stringent for a personal loan than for a home equity loan. And remember that defaulting on a personal loan will negatively impact your credit.

“Personal loans offer speed and simplicity and are best suited for urgent, short-term needs such as medical bills or emergency repairs, especially when home equity is unavailable or timing is critical,” says Ryan Zomorodi, co-founder and COO of RealEstateSkills.com.

When to choose a home equity loan

There are three key reasons why you might want to choose a home equity loan over a personal loan:

1. You want a lower interest rate. A home equity loan tends to offer lower rates, since they are secured loans that provide less risk for the lender. If you can afford the monthly payments, this loan may be a good option.
2. You desire long-term affordability. Home equity loans typically have longer repayment periods; some extend up to 30 years. Longer loan terms mean lower monthly payments.
3. You need a higher loan amount. Personal loans offer a narrower borrowing threshold. However, the amount you can borrow with a home equity loan depends largely on the equity you have in your home. If you’ve accrued a significant amount, you may have a much higher borrowing threshold.

“This financing works well for large, long-term investments like renovations, particularly for homeowners planning to stay put and seeking lower borrowing costs,” Zomorodi says.

How to get a personal loan or home equity loan

Take the time to learn more about the application process for both home equity loans and personal loans. Be aware that some aspects of the process are similar, while others are unique to each loan type.

Applying for a home equity loan

To get a home equity loan, prepare to follow these steps:

1. Check your credit score and DTI ratio. Before you begin the loan process, check your credit report to make sure you meet at least the minimum credit requirements for a home equity loan. It could also help you calculate your DTI ratio ahead of time.
2. Research multiple lenders. While you could borrow through your current mortgage lender, you may want to consider other traditional banks, credit unions, and online lending platforms as well. Each can offer unique promotions and benefits.
3. Get a home appraisal. Once you choose a lender, they’ll have your home appraised to determine how much you can potentially borrow. This generally means an appraisal fee that’s paid by the borrower.
4. Collect your documentation. When you apply for a home equity loan, be prepared to show plenty of paperwork. Your lender may 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.
5. Submit an application. Once you have all your documents, you can fill out and submit an application. From there, your lender will review your personal finances and check your FICO^® Score before approving you for a home equity loan.

Applying for a personal loan

Applying for a personal loan is usually an easier and faster process than applying for a home equity loan. As with a home equity loan, you should begin by checking your credit and comparing rates and terms from different lenders. You may also consider using a loan calculator to find the best personal loan product for your situation.

To get an idea of your potential interest rate, it’s best to get prequalified for a loan. Prequalification requires a soft credit check, which won’t affect your credit score. Once you’re ready to fill out a full application, gather the necessary documents and submit your completed form to the lender.

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 likely receive your loan funds in 1 to 7 business days.

In certain cases, Rocket Loans can offer same-day financing for personal loans, so the money could reach your account the same day you’re approved.

Home equity and personal loan alternatives

A home equity loan or personal loan isn’t your only choice. Check out these alternatives.

Home equity line of credit (HELOC)

A HELOC works similarly to a home equity loan. However, instead of being paid in one lump sum, the loan is structured as a credit line. You can use as little or as much of your total loan amount as you need. A HELOC includes a draw period (when borrowers can use their loan funds) and a repayment period (when loan payments are due and the credit line closes). A HELOC also can lead to foreclosure if you default, as it requires pledging your home as collateral.

Cash-out refinance

A cash-out refinance may be ideal if you need more money. You can refinance your mortgage for a lower interest rate and take out cash from your home’s equity at closing. The amount of equity borrowed is rolled into the new loan amount.

0% introductory APR credit card

If you have a good credit score, you may qualify for a credit card that offers a 0% APR during a promotional period. You can usually use this kind of credit card to transfer the balance of a high-interest rate credit card as a kind of debt consolidation. Though you’ll then pay 0% APR, many cards charge a balance transfer fee. Also, once the promotional period concludes, your purchases will accrue standard interest rates.

That’s why it’s smart to create and stick to a repayment plan when using a 0% APR credit card.

The bottom line: Home equity loans and personal loans offer unique benefits

The choice between a home equity loan and a personal loan comes down to your priorities and financial situation. If you’re looking for speed and flexibility, a personal loan can deliver quick funding without risking collateral. The downsides of this type of loan are smaller borrowing limits and higher interest rates. If you’re comfortable using your home as collateral, you can access larger loan amounts at a lower interest rate. When you use your home as a guarantee for a loan, you risk foreclosure if you’re unable to make the payments on the loan.

 Before you decide what’s right for you, compare the terms of each kind of loan and consider your financial ability to make the payments.

If you’re interested in learning more about your personal loan options, you can reach out to Rocket Loans² today.

¹Same Day Funding available for clients completing the loan process and signing the Promissory Note by 4:00PM 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 which may occur due to incorrect routing number, account number, or errors of your financial institution.

²All personal loans are made by Cross River Bank, a New Jersey state chartered commercial bank, Member FDIC, Equal Housing Lender. All loans are unsecured, fully amortizing personal loans. Eligibility for a loan is not guaranteed. This is not a deposit product. Please refer to our Disclosures and Licenses page for state-required disclosures, licenses, and lending restrictions.

Borrower must be a U.S. citizen or permanent U.S. resident alien at least 18 years of age. All loan applications are subject to credit review and approval. Offered loan terms depend upon your credit profile, requested amount, requested loan term, credit usage, credit history and other factors. Not all borrowers receive the lowest interest rate. To qualify for the lowest rate, you must have excellent credit, meet certain conditions, and select autopay. Rates and Terms are subject to change at any time without notice.

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