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Personal Loan vs. Mortgage: Which Is Best?

TLDR

What You Need To Know

  • Mortgages typically finance real estate purchases, while personal loans are more versatile
  • When it comes to upfront expenses, you’ll pay more for a mortgage than for a personal loan
  • Personal loans typically have higher interest rates than mortgages – but this isn’t a cut-and-dried rule

Contents

If you’re new to the world of finance, it can be challenging to choose the lending option for you. Mortgages and personal loans are a couple of the most popular choices. Both involve borrowing money and paying back over time, but similarities end there.

Depending on your goal (or goals), one loan can be a better fit than the other. Let’s take a closer look at their differences to help you decide which one better suits your needs. 

Mortgages vs. Personal Loans: What’s the Difference? 

Mortgages typically finance real estate purchases, while personal loans are more versatile and can be used for purchases and investments. Think of it this way: You can take out a mortgage to buy a home and use a personal loan to finance your home improvement projects.

But the differences don’t end there. Mortgages and personal loans have different repayment plans, interest rates, upfront costs, and risk levels. 

Differences in repayment timeline

Mortgage loans have different repayment timelines and are typically lengthy. Some of the most common fixed-rate home loans span 15 – 30 years.

Personal loans are usually paid back in shorter time frames because the loan amounts are smaller than mortgage loans. Personal loans are typically paid back in 7 years max. 

Down payments and upfront costs 

When it comes to upfront expenses, you’ll pay more for a mortgage than a personal loan. A home buyer’s most significant upfront expense will be the down payment they make on a mortgage.

A down payment, which ranges from 3% to 20% or higher, is the money you pay toward a home’s purchase price. This money jump-starts your home equity (think: the amount of home you own). And the balance of the home’s purchase price is covered by the lender. The amount your lender pays is your mortgage, and you’ll repay it over the loan.

Let’s say you want to buy a $500,000 home with a conventional loan and make a 20% down payment (which equals $100,000). With a 20% down payment, you would likely avoid a higher interest rate and private mortgage insurance.

You’ve probably read or heard that many experts recommend 20% down payments, but you can get conventional home loans and government-backed loans with no down payment as long as you meet the loan’s requirements. 

While personal loans have some upfront expenses, like application or origination fees, they usually won’t require a down payment. 

Secured vs. unsecured personal loans

A secured personal loan must be backed by collateral (think: your car, home, or another valuable asset you own). If you miss payments (aka default), the lender can keep your collateral to recoup their losses.

But most personal loans are unsecured and (you guessed it!) don’t require collateral. That’s a big difference. Personal loans typically don’t require collateral, while mortgages do – and it’s your home. If you default on your mortgage, your lender has the right to take ownership of the house. 

Because most personal loans aren’t secured by anything valuable, lenders assume more risk. As a result, a lender might require a higher credit score or lower debt-to-income (DTI) ratio for approval. And the loan will likely have a higher interest rate than your average mortgage. 

Interest Rates

Personal loan lenders don’t have the same protections as mortgage lenders because personal loans are typically unsecured and don’t require collateral. There is no option to repossess property, so personal loans usually have higher interest rates than mortgages – but this isn’t a cut-and-dried rule. 

Whether you’re applying for a mortgage or personal loan, lenders will take a long look at your financial history, including your income, credit report, and debt, to determine your loan’s interest rate. 

Is It Better To Take a Personal Loan or a Mortgage?

The answer to the question comes down to what you need financed. Mortgage loans can only be applied toward real estate purchases, while personal loans can be approved for a broad range of assets and investments. 

In some instances, personal loans can be used to purchase a property. But they are rarely the best choice. Usually, a mortgage loan is a better option as they offer higher loan limits, lower interest rates, and longer repayment terms.  

When do you need a personal loan?

Unlike mortgages, there are virtually no restrictions on how you can use personal loans. Some examples include:

  • Home renovation projects: Renovation projects are often used to boost a home’s value and are usually covered by personal loans. If the right upgrades are made, savvy borrowers can cover the cost of the personal loan with the added value of the renovations. 
  • Debt consolidation: If you’re struggling to pay off high-interest debt, like credit cards, you can use a personal loan to consolidate your debt. By combining all your loans and credit accounts into one loan, you’ll only make a single monthly payment on your debt. 
  • Large purchases and expenses: Personal loans are often used to finance a significant asset. If you’re a business owner who needs to buy a piece of equipment but doesn’t have the cash on hand, a personal loan can be the bridge to cover the money gap and fund the purchase.

When do you need a mortgage?

Personal loans offer variety. Mortgages have a specific use. You cannot use the money from a mortgage to purchase or refinance anything other than real estate. 

Whether you’re an aspiring first-time home buyer or want to buy an investment property, mortgage financing is the way to go. 

But mortgage loans offer a wealth of variety. Speak to a real estate professional to determine which home loan option is best for your real estate goals. 

Pros and Cons of a Mortgage

Taking out a home loan is a big decision. You should have a good understanding of the pros and cons of a mortgage before you apply. 

PROS of a mortgage👍

Lower interest rate

Because mortgage loans are insured by the home you’re purchasing, you’ll usually get a relatively lower interest rate than you would with personal loans.

Higher credit score

Similar to all forms of debt, making regular, on-time payments can help improve creditworthiness. This increases your borrowing capacity over time, opening new financing opportunities as your equity in the home goes up.

Tax benefits

You can deduct mortgage interest and property taxes from your federal income tax.

CONS of a Mortgage👎

High upfront costs

Mortgages are expensive. Between loan processing fees, closing costs, and the down payment, upfront costs can be difficult for first-time home buyers.

Risk of foreclosure 

If you can’t make your mortgage payments, your credit score will take a hit – and even worse – you could lose your home.

Changing rates

If your mortgage has a variable rate, the cost of your monthly mortgage payments is tied to the ups and downs of the economy. If interest rates skyrocket, so will the amount you pay each month.

Pros and Cons of a Personal Loan

Personal loans usually have smaller borrowing limits than mortgages, but no matter how much or how little you borrow, the loans can have a significant impact on your financial health. Here are some of the pros and cons of personal loans:

PROS of a Personal Loan👍

No down payment required

Mortgages typically require down payments. That’s not the case with personal loans. No down payment is required.

Flexible repayment terms

Personal loan lenders offer more flexible repayment terms than mortgage lenders. If you run into hard times, your lender may be more willing to negotiate an alternative payment plan.

Faster financing timeline

With personal loans, you receive your money in a matter of days – not weeks or months like a mortgage. Their expedited timelines make personal loans a great option for emergencies.

No collateral

Unlike mortgages, most personal loans don’t require assets to secure them.

CONS of a Personal Loan👎

Typically higher interest rates

Because personal loans are unsecured, your lender has no assets to make up for their financial loss if you default on the loan. To minimize their risk, lenders will usually charge higher interest rates.

Shorter repayment timeline

Mortgage repayment can span decades. But personal loans are paid back on shorter timelines, which could mean higher monthly payments depending on the length of the loan.

More debt

Getting a personal loan might not be a good idea if you’re already struggling to pay your bills. Missed payments can result in significant fees and a plunging credit score.

Can You Use a Personal Loan as a Down Payment on a House? 

In short, no. Lenders generally won’t let you use a personal loan as a down payment on a house. You’ll need to find that money somewhere else. 

Using a personal loan to make mortgage payments is also not recommended because you’re stacking one debt right on top of another. Starting your homeownership journey with one loan (your mortgage) is a big responsibility – financially or otherwise. Adding a personal loan to the mix will increase your debt load and may lead you into a cycle of debt that’s hard to escape. You could be playing catch-up for a long time.

If you can’t make a 20% down payment, there are different mortgage loan options that lower this common barrier to entry. For example, FHA loans – which help home buyers (especially first-time home buyers) with credit or savings issues – allow borrowers to make down payments as low as 3.5%.

Banking on Your Future

So what’s the most significant difference between personal loans and mortgages? Your goals. If you want to invest in real estate, opt for a mortgage. A personal loan will serve you better if you renovate your home, consolidate your debt, or need to pay for expensive items.

ICYMI

In Case You Missed It

  1. Before issuing a loan, lenders will take a long look at your financial history, including your income, credit report and debt, to determine your loan’s interest rate

  2. Lenders usually won’t let you buy a house with a personal loan

  3. Mortgages are typically paid over 15 – 30 years. Personal loans are paid back in shorter time frames

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