Explore your mortgage options
Sometimes the unexpected happens. Or, opportunities come along that won’t last forever. Whatever the reason, there are times when you need to take out a loan to cover expenses.
If you own a home, you have options. In this article, we’ll compare two of the most popular loan options available: home equity loans versus personal loans. We’ll explain the differences and the strengths and weaknesses of each, so you can make the best choice for your situation.
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Home Equity Loans and Personal Loans: Key Differences
There are several important differences between these two loan options you need to understand in order to make an informed decision.
- Home equity loans: Secured loans
- Personal loans: Unsecured loans
An unsecured loan is a loan that doesn’t require collateral. In other words, the lender doesn’t require rights to an asset in order to issue the loan.
With a home equity loan, your home operates as the collateral. If you don’t pay back the loan, your house could be foreclosed upon.
- Home equity loans: $45,000 – 85% of your home equity
- Personal loans: $2,000 – $45,000
An important distinguishing feature between these two loan types is how much you can borrow. For personal loans, the minimum amount you can borrow is significantly lower than for a home equity loan. The maximum is also a straightforward dollar amount set by the lender.
The minimum you can borrow with a home equity loan will vary by lender, but you might struggle to find a reputable lender willing to let you take out a home equity loan for less than $45,000.
The maximum amount you can take out with a home equity loan will be determined by how much equity you have. The exact percentage will also vary by lender, but 85% of your equity value is a common maximum. This can lead to big differences depending on the value of your home.
If your home is worth $300,000, then 85% equity would be $255,000. If your home is worth $400,00, then 85% equity would be $340,000.
When you apply for a home equity loan, your home’s value will be determined by an appraisal.
- Home equity loans: Slightly above mortgage rates, which have fluctuated between 6% – 8% in 2023.
- Personal loans: Typically 11% or higher depending on your credit.
When looking at interest rates, there are some important caveats to note. Your credit score, debt-to-income (DTI) ratio and lender will affect your interest rates.
That said, personal loans generally have higher interest rates than home equity loans. For their part, home equity loan interest rates are usually slightly higher than mortgage rates because lenders consider second mortgages like home equity loans to be riskier.
- Home equity loans: Closing costs, origination fees
- Personal loans: Origination fees
One of the downsides of a home equity loan is that because it is another mortgage, you’ll owe closing costs, which usually are 2% – 6% of the loan’s value. That can be a significant sum depending on how much you borrow.
With personal loans, it’s more typical to only pay the loan’s origination fee, which will vary by lender. Annual percentage rate (APR) combines interest rates with lender fees, calculating the total cost of borrowing money. It’s a helpful tool when comparing different lenders.
Both home equity loans and personal loans can come with late payment fees or early payment penalties. The specifics will depend on the agreement with your lender.
- Home equity loans: 5 – 30 years
- Personal loans: 12 – 60 months
The exact time frame of your repayment terms and how soon you need to start making payments will vary by lender. That said, personal loan repayments are generally measured in months, while home equity loan repayments are measured in years.
Typical processing time
- Home equity loans: Weeks
- Personal loans: Days
Home equity loans require an appraisal, title search and other steps that make the application process significantly more involved. For that reason, it’s common for it to take weeks to close on a home equity loan.
Personal loans on the other hand can be processed quite quickly. In some cases, an application can be approved in as little as one business day.
Home Equity Loan vs. Personal Loan Pros and Cons
Here’s a list of strengths and weaknesses for each loan type in relation to the other.
Home equity loans
Depending on how much equity you have, you may be able to borrow significantly more with a home equity loan than a personal loan.
Even though home equity loan interest rates are usually higher than mortgage rates, they’re still generally lower than personal loan interest rates.
Home equity loans usually come with longer repayment terms. Depending on how much you borrow, this could translate into lower monthly payments.
Because the home acts as the collateral for the loan, if you don’t make your payments you could wind up losing your home.
You’ll need to pay closing costs for a home equity loan. This can be a significant sum depending on how much you borrow.
It takes time for a lender to approve a home equity loan. If you’re in a rush for the funds, you won’t be able to access them quickly with this type of loan.
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You don’t have to make a down payment or risk losing your home in order to get a personal loan.
You can get access to the funds you need much faster with a personal loan than with a home equity loan, assuming your application is approved.
You don’t need to pay closing costs on a personal loan, making it cheaper to access the money than with a home equity loan.
Higher interest rates increase both your monthly payment and the total amount you’ll pay in interest over the life of the loan.
You won’t be able to borrow as much with a personal loan as you would with a home equity loan. So make sure that the amount you can borrow is enough to cover expenses.
When Does a Personal Loan or Home Equity Loan Make Sense?
We’ve put together a list of common situations potential borrowers face so you can see which loan option would be better suited for that situation.
|Situation||Personal Loan||Home Equity Loan|
|You need cash fast||✅|
|You need to borrow a larger sum||✅|
|You don’t have strong credit||✅|
|You don’t have a lot of equity||✅|
|You plan to sell your home soon||✅|
|Your home’s value is increasing||✅|
The chart should be used as a starting point. Make sure to discuss all of your options and the nuances of your finances with your lender before coming to a decision.
Personal loans and home equity loans aren’t your only financing options. Here are some popular alternatives:
- Home equity line of credit (HELOC): This is a revolving line of credit based on your home’s equity. This is a flexible borrowing option that allows you to take funds as needed during the draw period.
- Cash-Out Refinance: This option replaces your current mortgage with a larger mortgage. You get the difference in cash. Cash-out refinancing gives you the lowest rate of all home equity borrowing choices.
- Credit cards: You can always use credit cards to cover expenses. Just be mindful that they come with some of the highest interest rates, and that your credit utilization percentage affects your credit score.
Final Thoughts on Choosing Between Home Equity Loans and Personal Loans
Both of these loan options can provide you with funds that can be used in a variety of ways. Make sure to take the time to properly assess your financial circumstances, how much you need and when you need it before coming to a decision.
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The Short Version
- Personal loans are usually unsecured loans, meaning they don’t require collateral. Your home serves as the collateral for a home equity loan
- Home equity loans allow you to borrow more depending on how much equity you have. But the minimum you can borrow is higher than the minimum for personal loans
- Personal loans generally have higher interest rates than home equity loans
- ST. LOUIS FED. “30-Year Fixed Rate Mortgage Average in the United States.” Retrieved October 2023 from https://fred.stlouisfed.org/series/MORTGAGE30US
ST. LOUIS FED. “Finance Rate on Personal Loans at Commercial Banks, 24 Month Loan.” Retrieved October, 2023 from https://fred.stlouisfed.org/series/TERMCBPER24NS