Home equity loans and personal loans are both installment loans that offer upfront lump sum payments, and each can be used for various financial needs. However, they have some key differences. The option that’s best for you depends on your needs and unique financial situation.
- What’s the difference between home equity loans and personal loans?
- What can you use these loans for?
- When is a home equity loan the right choice?
- Pros, cons of home equity loans
- When is a personal loan the right choice?
- Pros, cons of personal loans
- Alternative financing options
What’s the difference between home equity loans and personal loans?
The primary difference between home equity loans and personal loans is in their collateral requirements. A home equity loan allows you to borrow money using your home’s equity as collateral, making it a secured loan. Because of this, there can be a significant risk if you’re unable to make loan payments. If you default on your loan, the bank can foreclose on your house.
Personal loans are generally unsecured loans, although secured personal loans also exist. Instead of requiring collateral, personal loan applications are approved based on your credit and other financial information as required by the lender’s underwriting guidelines.
These loan types also differ when it comes to loan amounts and repayment terms. Home equity loans allow you to borrow up to 80% of the equity you have in your home, meaning you can borrow a significant amount of money. Most personal loans only go up to $50,000, though you can find lenders that offer as much as $100,000. And while home equity loans can have repayment terms up to 30 years, personal loan terms typically max out at seven years.
One area where home equity loans and personal loans are similar is their interest rates. Both typically have fixed rates. A fixed-rate doesn’t change for the entirety of the loan term, unlike variable rates, which can fluctuate during the repayment period.
What can you use these loans for?
You can use home equity loans and personal loans to pay for almost anything. Some common uses for both loan options are:
- Home improvements
- Debt consolidation
- Paying medical bills
- Starting a business
- Paying for a wedding or other events
- Funding a vacation
- Purchasing a new vehicle
- Moving costs
- Emergency expenses
- Large purchases
When is a home equity loan the right choice?
A home equity loan could make sense if:
- You have enough equity in your home to qualify.
- You need to cover a large purchase that’s over $50,000.
- You have high-interest debt and want to pay it off at a lower interest rate.
- You have major home improvement projects coming up. After 2025, you can deduct home equity loan interest payments on your taxes if you use the loan funds for home improvements.
- You want a long repayment term for your loan.
- You know you can repay the loan on time. Home equity loans have higher stakes than personal loans, so you should only take one out if you’re confident you can repay it as agreed.
As beneficial as a home equity loan can be, it may not be the right choice if:
- You don’t have enough equity built up in your home yet to cover the amount you need.
- You’re not able to make the monthly payments.
- You’re unsure of how much you need to borrow. A revolving credit line, like a home equity line of credit (HELOC), would make more sense for ongoing access to cash.
- You’re planning to sell your home soon. You may not make enough from the sale to settle your mortgage and home equity loan.
Pros and cons of home equity loans
There are benefits and downsides to home equity loans, including:
Pros
- Fixed interest rates: Home equity loans come with a fixed interest rate that won’t increase over the life of the loan, regardless of economic conditions.
- Lower rates: Home equity loans may have lower interest rates than other types of financing because of the collateral required.
- Large loan amounts: You can borrow a very large sum of money with this type of loan, depending on the amount of equity you have in your home.
- Predictable payments: With a fixed rate, your payments won’t change throughout the loan term.
Cons
- Collateral: Home equity loans use your home as collateral. If you default on your loan, the bank can foreclose on your home.
- Added costs: You may have to pay closing costs and upfront fees when you take out a home equity loan.
- Two mortgage payments: A home equity loan is separate from your home mortgage, creating two monthly mortgage payments.
- Requires significant home equity: You typically need to have at least 20% to 30% equity in your home.
When is a personal loan the right choice?
A personal loan could be a good option if:
- You don’t have home equity.
- You have a financial emergency and need fast access to cash.
- You have good enough credit to score a low-interest rate (at least a 670 FICO score).
- You can afford the monthly loan payments.
- You have high-interest debt you need to pay off.
- You don’t want to risk any collateral.
Pros and cons of personal loans
Personal loans also have pros and cons to consider, such as:
Pros
- No collateral required: In most cases, you don’t need to provide collateral to secure a personal loan. Lenders typically rely on a credit check and other financial information to determine your eligibility for a personal loan.
- Fast funding: Many lenders disburse loan funds soon after loan approval, often as soon as the next business day.
- Flexible terms: You can often choose your repayment term based on the monthly payment amount you want.
Cons
- Fees and penalties: Personal loans sometimes include fees like an origination fee for processing the loan, which is typically a percentage of your loan amount. Lenders may also charge a prepayment penalty if you pay off your loan early.
- Credit requirements: To qualify for a personal loan, you must meet credit and other lender requirements. Lenders also use your credit information to set loan rates.
- Higher interest rates than secured loans: Unsecured personal loans may have higher interest rates than home equity loans and other types of secured financing.
Alternative financing options
Home equity loans and personal loans offer many benefits for borrowers but may not be a good fit for everyone. Here are some alternative financing options to consider:
- HELOC: A HELOC is a revolving line of credit you can draw from, up to your credit limit, as needed.
- Cash-out refinance: A cash-out refinance is a new, larger mortgage loan to replace your existing mortgage. This lets you pocket the extra money to use however you want.
- Credit cards: A credit card can be a useful financing option. It offers a revolving line of credit and only requires a minimum monthly payment. However, it’s always best to make the full payment each month to avoid interest charges. Credit cards also charge higher rates than home equity loans and other loan types.