When you want to borrow money to do work on your home or make another sizable purchase, you’ll have to decide what type of loan you want to use. Home equity loans and personal loans are two common ways to cover larger expenses, each with its own advantages and disadvantages. Before you decide which one of these loan types you should choose, you should have a good understanding of how they work.
How Does A Home Equity Loan Work?
When you take out a home equity loan, your lender gives you a single, one-time cash payment that you agree to pay back in monthly installments over time, with interest. A home equity loan uses your property as collateral to secure the loan. In other words, if you fail to make your payments on time, the lender has a right to repossess your property.
You can use the proceeds of a home equity loan almost any way you want. Common examples of how people use home equity loans include home renovations, consolidating debt, emergency expenses, paying for a wedding or covering education costs.
Advantages Of Home Equity Loans
Home equity loans are popular because they offer many distinct advantages, including:
- Fixed interest rates.
- Longer repayment periods than many other types of loans.
- Higher maximum loan amounts than many other types of loans.
- Lower interest rates than many other types of loans.
- Flexibility to use the money how you want.
- Potential tax deductions on the loan interest if you use the funds to buy, build or substantially improve a residence.
Disadvantages Of Home Equity Loans
Though home equity loans can be a great way to borrow money against the equity you’ve built up in your property, there are some disadvantages to consider, including:
- You risk losing your home if you don’t make your payments on time.
- You’ll only receive a one-time payment.
- You’ll pay interest on the full amount you borrow, even if you don’t use it.
- Strict qualification requirements.
- Fees can range from 2% – 6% of the loan amount.
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How Does A Personal Loan Work?
When you take out a personal loan, a lender gives you a lump-sum payment. In exchange, you agree to pay back the money you borrow in monthly installments, including an additional fee for interest charges.
Advantages Of Personal Loans
- Faster approval and faster funding than many other types of loans.
- You don’t need to use your house as collateral.
- Interest rates tend to be lower than credit card rates.
- Longer repayment terms than some other types of loans.
- Fixed interest rates and predictable monthly payments.
Disadvantages Of Personal Loans
- You’ll need a strong credit score to qualify.
- Interest rates tend to be higher than home equity loan rates.
- Fees can range from 1% – 5% of the loan amount.
- The maximum loan amount may not be as high as what you need.
Personal Loan Or Home Equity Loan: What’s The Difference?
| Loan Type | Personal Loan | Home Equity Loan |
|---|---|---|
| Loan Requirements | Minimum 580 – 660 | Minimum 620 |
| Repayment Period | Typically 1 to 7 years | 5 to 30 years |
| Requires Collateral | No | Yes |
| Loan Amount | Up to $100,000 | Up to 85% of your home’s equity |
| Approval Time | Typically 1 to 3 business day | Typically 2 to 4 weeks |
| Fees | 1% to 5% of the loan amount | 2% to 6% of the loan amount |
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When A Home Equity Loan Might Be Right For You
Home equity loans are one of several options you can consider if you need to borrow money. Here’s when a home equity loan might be right for you.
You’re Looking To Borrow A Large Sum Of Money
Home equity loans allow you to borrow large sums of money as long as you have enough equity in your home to secure the loan. For example, if you have $200,000 in home equity and your lender allows you to borrow up to 80% of that, you could get a home equity loan for as much as $160,000.
You’re Comfortable With A Second Mortgage
If you’re comfortable using your home as collateral and having a second mortgage payment, a home equity loan can be a great way to tap into your home equity.
Lower Interest Rates Are Your Top Priority
Home equity loans tend to offer lower interest rates than many other loans. If locking in a lower interest rate is one of your top priorities, a home equity loan is one of the best options available.
You Want More Time To Repay The Loan
The repayment period on a home equity loan can be as long as 30 years, giving you the option to spread out your payments over a longer term.
You Want To Take Advantage Of Potential Tax Deductions
With a home equity loan, you may be able to deduct the cost of mortgage interest from your taxes. In most cases, the Internal Revenue Service (IRS) allows you to deduct all the mortgage interest on a home equity loan provided that you use the funds to buy, build or substantially improve the property against which you’re taking the loan.
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When A Personal Loan Might Be Right For You
If you’re looking for borrowing options besides home equity loans, a personal loan might be right for you under the following conditions.
You Have Good Credit
Though some lenders may issue personal loans to borrowers with a credit score as low as 580, many others will require a minimum credit score of 660. Since personal loans are often unsecured, a higher credit score can help you secure the best interest rates on a personal loan.
You Need The Money Faster
You can get approved for a personal loan in as little as a few hours, and in most cases, it only takes a few days for lenders to review a personal loan application. If you need the money faster, a personal loan may be a better option than some other loan types, like a home equity loan or home equity line of credit.
You Don’t Want To Use Collateral To Secure The Loan
Home equity loans and other second mortgages require you to use your house as collateral. If you don’t own a home, you don’t have enough equity or you just don’t feel comfortable with a second mortgage, a personal loan gives you the option to borrow money without risking repossession of your home.
You Need To Borrow Less Than $100,000
Most personal loans have limits of up to $50,000 or $100,000, so if you’re looking to borrow less than that and you’re not interested in a home equity loan, a personal loan should meet your needs.
The Bottom Line
When you’re evaluating whether to take out a home equity loan versus a personal loan, think about your borrowing needs. Consider your priorities and how each of these loans might help you achieve your goals. Remember, you’ve got options, so choose the one that checks the most boxes off your list.
Mary Grace Schmid
Mary Grace Schmid is a freelance writer covering homeownership, personal finance and lifestyle topics. She has a bachelor's degree in public relations from Baylor University with a minor in political science. She enjoys photography, music and reading in her free time.
