Home Equity Loan Vs. Personal Loan: Which Is Better For You?
4-Minute ReadJanuary 10, 2022
Homeowners with enough equity in their homes can apply for a home equity loan. Such loans are considered a low-cost way to finance a major purchase, pay down credit card debt or cover an emergency expense. However, putting one’s house up for collateral can be risky, and personal loans can be just as affordable without needing collateral.
This article will show you the similarities between a home equity loan and a personal loan, and cover what you should consider before applying for either one.
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 types allow you to use funds for almost any reason, such as a home improvement project or debt consolidation, but it's important to know the differences between them.
Take a look at the chart below for the main differences between home equity and personal loans.
Home Equity Loan
You borrow against the equity in your home. If you have $70,000 of equity, for example, you might be able to qualify for a home equity loan of $60,000.
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 credit score, income and debts to determine if you qualify and at what interest rates.
You pay back a home equity loan in monthly installments, with interest.
Your home equity is not involved. Lenders look at your credit score and debt-to-income (DTI) ratio to see if you qualify for a personal loan and how much they are willing to lend you.
Most personal loans require no collateral. If you stop making payments, lenders can't take your car, home or any other asset. Lenders can, however, send your defaulted loan to collections, and your credit score can take a big hit.
Lenders will also look at your credit score, income and debts when setting your interest rate and determining if you qualify for a personal loan.
Just as with home equity loans, you pay back your personal loan in regular monthly payments that include interest.
How Do Personal Loans Work?
As listed in the above chart, 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 that you pay back over time, usually in fixed monthly payments. 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, the better rates and terms you're likely to receive.
How Does A Home Equity Loan Work?
Home equity loans are a type of secured loan where your home acts as collateral. As mentioned in the chart, if you can't pay back your loan, the lender has the right to seize your home through the foreclosure process. The loan amount you qualify for is determined by 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 than one they'd get when taking out unsecured loans. That's because the risk to lenders is lower. If you stop making payments, they can take possession of your home, giving them a financial safety net.
Terms can also be much longer with a home equity loan. Just like with 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 come with 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.
Home Equity Loan Or Personal Loan: Which Is Better?
Both home equity and personal loans offer advantages and large amounts of cash, depending on your requirements and financial situation. Either loan comes with risks and differing qualification requirements, too.
Let's take a look at the strengths of each option so you can determine what type of loan you need.
When To Choose A Personal Loan
Here are some common reasons you might want to consider applying for 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 a 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. In fact, a personal loan is often your best option if you're looking to borrow a smaller sum (think under $50,000).
You Want An Unsecured Loan
As was mentioned above, most personal loans are unsecured – meaning you won't need to front any collateral. Instead, your loan approval will be contingent upon your credit score, income and other financial circumstances. If worse comes to worst, defaulting on your payments may negatively affect your credit score, but it won't cause you to potentially lose your home.
When To Choose A Home Equity Loan
Here are some common reasons you might want to consider a home equity loan:
You Want A Lower Interest Rate
Home equity loans tend to have lower interest rates than other types of loans. If you believe you can make on-time payments and are comfortable with the risk of losing your home if you don't, then this could be a good option for you.
You Want Long-Term 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 of which can last as long as 30 years. Generally, that means your monthly payments may be lower, and you could have more options for your repayment.
You Need To Borrow More Money
Rocket Loans℠ offers personal loans amounting from $2,000 – $45,000. If you want to borrow a larger sum of money, it could be a better idea to go the home equity loan route, especially if you have significant home equity. Of course, always remember that what you borrow will need to be repaid – with interest.
How To Get A Home Equity Loan Or Personal Loan
There are some important differences in the process of applying for a home equity loan and a personal loan, respectively. Here's what you can expect:
Applying For A Home Equity Loan
When you apply for a home equity loan, be prepared to show plenty of paperwork. Lenders need proof that your income is high enough and your debt is low enough that you can afford your monthly payment.
Your lender might ask for copies of your most recent bank account statements, paycheck stubs, tax returns and W-2 forms. They might also ask for your most recent credit card statements.
Lenders will also review your three credit reports, each maintained by the national credit bureaus of Experian®, Equifax™ and TransUnion®, and pull your three-digit FICO® credit score.
The higher your score, the more likely you are to get approved and the lower your interest rate will be. Most lenders consider a FICO® Score of 740 or higher to be particularly strong.
Applying For A Personal Loan
Applying for a personal loan is usually an easier, and faster, process. Typically, you'll log onto the website of a personal lender or lending platform, review its terms and fill out the online loan application.
This usually requires that you provide such basic information as your name, current address and employment information. Lenders might also require that you provide copies of your recent bank account statements and paycheck stubs so that they can verify your income.
You might also need to provide proof of your address. This can include a copy of your personal identification, such as a driver's license, or a copy of recent utility bills.
Lenders, as they do with home equity loans, will also check your credit score and credit reports.
Lenders 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 you could possibly see your money in your account the same day you’re approved.*
Alternative Loan Options
It’s possible neither loan will work for your current situation. If that’s the case, here are some other options you could consider.
A home equity line of credit, or HELOC, works similarly 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 can 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 the risk of foreclosure.
If you want a higher loan amount with a faster approval process, consider a cash-out refinance. This method allows you to refinance your mortgage for a lower rate while converting your equity into cash for yourself. It's a good way to get a quick loan if you're a homeowner with some accrued equity.
0% Introductory APR Credit Cards
Some credit card issuers offer 0% APR promotional periods when you sign up for a new card, giving you 12 – 18 months of interest-free spending money. Once that period ends, though, you’ll be hit with high interest rates for your remaining balance.
There are no hard and fast rules when deciding between a personal loan or 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 want to receive money faster but at a potentially higher 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.
*Same 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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