Home Equity Loans Vs. Personal Loans: A Guide

For times when you need to borrow money or consolidate debt, both home equity loans and personal loans fit the bill to get the job done. However, taking out a loan is a major decision and knowing the right one to pick for your situation can be tricky. Both loan types usually have fixed interest rates, but one typically has lower rates and the other is easier to access quickly. Let’s compare home equity loans and personal loans and see if either loan fits your needs.

What Is A Home Equity Loan?

A home equity loan is a type of loan that gives homeowners the chance to tap into the equity that they’ve built into their home. To clarify, home equity is simply the difference between the worth of your home and the remaining mortgage balance. The equity allows homeowners to have and use the collateral to borrow funds. For example, if you still owe $100,000 on your mortgage and your home is worth $250,000, you have $150,000 worth in equity.

Home equity loans are a great option for homeowners with a low-interest mortgage who don’t want to go through a full refinance but want to borrow some of the home equity they’ve built. Because this type of loan is based on the value of your home, they are not designed with newer homeowners in mind. This is due to the fact that how much homeowners can borrow is linked to their loan-to-value ratio (LTV), which is based on your equity. Lenders will look at the potential homeowner’s debt between the mortgage and the equity loan to ensure that the debt total is less than the home’s estimated sale price.

Home equity loans are often referred to as a “second mortgage,” which means that you will need to pay closing costs and potentially have a home appraisal done. While home equity loans can be considered to be less risky, if you’re unable to pay back the loan, a lien on the property or even foreclosure are possible.

To help you consider whether a home equity loan is the right fit for you, here are some pros and cons for this type of loan.

Note: Rocket Mortgage^® offers a Home Equity Loan, as well as cash-out refinances, if you decide they’re right for you.

What Is A Personal Loan?

Like home equity loans, personal loans give borrowers an opportunity to use a sum of money that must be repaired. A personal loan is an unsecured loan that has no collateral, which means that there is nothing of value securing a loan. A borrower’s ability to secure a personal loan will depend on their income, debt-to-income ratio (DTI) and credit score – essentially, a borrower’s creditworthiness. Typically, a credit score of at least 650 can help a borrower obtain a personal loan with a good interest rate.

Since there is no collateral involved with personal loans, the time frame to get a personal loan is much faster than home equity loans but the repayment period can range from a year to around seven years. Keep in mind that the longer the term, the higher the interest rate will be.

Thinking that a personal loan may be the right fit for you? Let’s look at some pros and cons of using a personal loan.

Our colleagues at Rocket Loans℠ do offer personal loans. You can apply online now to get an estimate on how much you could borrow with a personal loan.

Home Equity Loans Vs. Personal Loans: What’s The Difference?

Secured Vs. Unsecured Loans

An important differentiation between home equity loans and personal loans is that one is secured and one is unsecured. Because a home equity loan is secured, that means that the loan is secured by your home’s equity.  The lender views your equity in your home as the asset to back the asset, which means the lender will place a lien on your home until the loan is repaid. If the loan is not repaid, the lender can foreclose on the home.

As an unsecured loan, a personal loan is not backed by collateral. Different lenders have varying requirements for unsecured loans, but unsecured loans typically require excellent credit and a secure income. If the lender is unable to pay loan back, their credit can be severely impacted.

Closing Costs Vs. Origination Fee

The cost to obtain a home equity loan or a personal loan are different, due to the nature of each loan. While the closing costs for a home equity loan are less than the costs would be for a standard mortgage, they still cost 2% –5% of the loan amount. The closing costs can include an origination, credit report, title or even an appraisal fee.

A personal loan’s cost is much lower, as lenders only charge an origination fee. These are an upfront cost to start a new loan application to cover any underwriting or verification fees. The origination fee is determined by the percentage of the original loan amount for the services required to get the loan.

Foreclosure Vs. Collections

The consequences for not being able to repay a home equity loan versus a personal loan are very different, but both still severe. Because a home equity loan is backed by your equity in your home, the lender can foreclose your home if you cannot repay the loan. If you cannot repay a personal loan, there’s no collateral for the lender to take. However, the loan account can go into default, the borrower’s credit can be damaged and the lender can even take the borrower to court. While these can impact a borrower’s ability to take out a loan in the future, it’s generally preferable to foreclosure.

Home Equity Loan Vs. Personal Loan: Questions To Ask To Help You Decide 

What Are Your Plans?

There are plenty of reasons to take out a loan, but what you need the money for can help you decide which loan is the better fit. If you are considering completing some home renovations, you may be able to deduct the loan interest with a home equity loan.

But if you don’t own a home or want to consolidate your debt, a personal loan may be the better fit for your needs. The timeliness of your plans could also impact which loan is a better fit for you, which we’ll discuss later.

What Is Your Credit Situation?

If you don’t know what your credit report looks like, be sure to check before deciding which loan to choose. If you have good to excellent credit, you can qualify for a personal loan and take advantage of their lower fees. However, if you have a poor credit score, a personal loan may not be possible to get.

If you own a home and have some equity, a home equity loan may be the better choice for you. Keep in mind that you may not be able to qualify for better interest rates if you apply for a home equity loan and you have shaky credit.

How Urgently Do You Need The Money?

If the time that it takes to obtain a loan is an important factor, the clear winner is personal loans. The process of a home equity loan includes determining the value of your home, which adds a few extra steps that a personal loan doesn’t require. A home equity loan requires an application, underwriting and potentially an appraisal before the loan is made.

So, if you’re not in a rush and want to do home renovations in the future, a home equity loan is still a great option. However, if you need money for an emergency, a personal loan is a better option. A personal loan can usually take a few days or a week for the borrower to receive the money, while a home equity loan can take up to a month.

The Bottom Line: Homeowners Have Borrowing Options  

Everyone has a different financial story – whether you have good credit, you have significant equity in your home or you need money for an emergency, the loan that you choose depends on you and your needs. By understanding the basics of both home equity and personal loans, you can decide which borrowing option fits your financial story. You can borrow against your home equity, if you have it, or borrow against your credit with a personal loan.

If you decide to get a home equity loan, you can apply online now to get the process started.