Personal Loans vs. Home Equity Loans: Which is Best For You?

Personal loans and equity loans can be used for home improvements, debt consolidation, medical expenses, and many other purposes. However, personal loans are usually better when you’re starting with a mortgage, whereas home equity loans are ideal when you’re looking for the lowest possible interest rates.

How do personal loans work?

Personal loans are offered by online lenders, banks, and credit unions and can be used for a variety of purposes, from financing large expenses to debt consolidation.

Borrowers with good to very good credit are more likely to get approved and get low interest rates. However, this does not mean that applicants with low to low credit scores cannot obtain personal loans.

Applying for a personal loan can be as simple as filling out an online form and providing an electronic record. However, because every lender structures their loan differently, it’s always a good idea to shop around before making a choice.

Compare the offers from multiple lenders and find out which one offers the best loan amount that suits your needs, as well as the repayment period and interest rate that suits your budget.

After you are approved for a loan, you can usually get cash within a few days and make regular monthly payments on the loan until it is paid off.

How do home equity loans work?

An equity loan is also known as a second mortgage. Your home capital is the value of your home minus the amount you owe on your mortgage.

Home loans allow homeowners to use the built-in equity in their homes to take out a loan. They usually allow borrowers to make payments for five to 15 years, although terms vary. Most lenders allow you to borrow up to 85 percent of the loan to the combined value of your home.

Additionally, equity loans have one major advantage over personal loans: lower interest rates. This is because the loan uses your home as collateral so the lender may have a claim on your home if you fail to meet your loan obligations.

Unlike personal loans, the process of applying for a home equity loan is a little more complicated. While you can often apply online, the process usually takes several weeks as your property requires an appraisal.

When you get a home equity loan, you get the full amount at once and have to pay it back in fixed monthly installments.

Personal Loans versus Equity Loans: Which Is Best For You?

Personal and equity loans can give you the money you need when you need it. However, there are situations where you would be a better choice.

Credit card debt consolidation

Howard Dworkin, CPA, and Chairman of Debt.com say personal loans are a better choice if you want to pay off your credit card debt.

“If someone has multiple credit cards with a value above $ 5,000 and a credit rating that qualifies them as a reasonable interest rate, a personal debt consolidation loan might be the right choice for them,” he said.

Making home improvements

The main difference between home loans and equity loans is that secured equity loans and home improvement loans are usually unsecured personal loans.

Due to the unsecured nature of home loans, these loans usually come with a higher interest rate but are ideal for borrowers who are planning a small or medium-sized renovation and don’t want to use their property or home as collateral.

When it comes to home renovations, Dworkin suggests sticking to home loans.

“This adds to the value of the home, rather than harms it, and helps consumers build equity over the long term,” he said. In addition, home improvement interest is tax-deductible if you use the loan to buy, build, or repair your home.

When to choose a personal loan

There are a few scenarios where a personal loan may be a better choice than a home equity loan:

• You have a smaller expense: While you may be able to find smaller home equity loan amounts at local credit unions, most banks set a minimum of $10,000 or more. Personal loans, on the other hand, may let you take out as little as $1,000.

• You don’t want to risk your house: Personal loans are usually unsecured, so you can’t lose your house or any other property if you default.

• You don’t have much equity: If you lack sufficient equity in your home, you may not qualify for a home equity loan at all.

• You have excellent credit: Having excellent credit will qualify you for the lowest personal loan rates, some of which may hover around 3 percent.

When to choose a home equity loan

In some cases, a home equity loan may be the best option available. You may want to consider a home equity loan if:

• You have a lot of equity: If you’ve built up a significant amount of equity in your home, you may be able to borrow upward of $500,000, far more than you would with a personal loan.

• You don’t have the best credit score: Because a home equity loan is a secured loan, it can be easier for people with bad credit to qualify — just know that you won’t receive the best interest rates.

• You’re looking for low rates: Home equity loan rates are typically lower than personal loan rates, meaning your monthly payment will be smaller and you’ll pay less for borrowing money.

• You want to renovate your home: If you use your home equity loan funds for renovations, you can deduct the interest paid on your taxes. 

Alternative loan options

Personal loans and equity loans are not the only ways to borrow large amounts of money. If you have different financial needs, try one of the following alternatives.

Home Equity Line of Credit (HELOC)

HELOC works like a credit card. You are given a credit line that is guaranteed by your home and these funds can be used for almost any purpose. HELOCs often have a lower interest rate than other types of loans and interest is tax-deductible.

Like an equity loan, you take a loan with your home’s available capital that is used as collateral. You can borrow as much as you want as often as you want during the entire cooling period – usually 10 years.

You can add to your available balance by making a payment during the withdrawal period. At the end of the withdrawal period, you start with a repayment period of 20 years.

To be eligible for a HELOC, you need capital in your home. As with equity loans, you can often borrow up to 85 percent of the value of your home less any outstanding mortgage balances.

When you apply, lenders check your credit history, monthly income, debt-to-income ratio, and your credit rating.

Most HELOCs have floating interest rates, which means your interest rates can vary over the life of your loan.

When interest rates go up, so do your payments. As with credit cards, the possibility of overspending is higher than fixed loans.

Without discipline and a certain amount of budget, you could be saddled with heavy payments during the payback period.

Credit card

Credit cards offer many advantages. Making payments on time each month can improve or improve your credit score.

Many credit cards offer cash-back rewards or travel miles that you can often redeem with certain airlines. They are as comfortable as cash and can be used as an emergency financial safety net.

However, credit cards have some drawbacks. Some credit cards charge high-interest rates for prepayments and balance transfers.

Late or late payments can damage your balance and there is always the possibility of credit card fraud on your account.

Additionally, some cards have high annual fees (from just $ 25 to over $ 1,200). If you pay with your credit card, additional merchant fees may apply, and additional fees can quickly appear.

Conclusion

Choosing between a personal loan and an equity loan will depend on your financial needs. Both types of loans have advantages and disadvantages that need to be considered before applying.

However, both are great options when you need to borrow money. In any case, take the time to compare all loan options, interest rates, fees, and payment terms before submitting your application.