Home Equity Loan Vs. Personal Loan: How To Choose

If you have a large expense coming up and are looking to help fund it, you may have several different options for financing. Two popular ones are a home equity loan and a personal loan. Both of these can provide a lump sum that you can use however you want while making regular payments over time. Deciding between a home equity loan vs. a personal loan will come down to your specific situation and financial needs.

Why Borrowers Choose Home Equity And Personal Loans

Both home equity loans and personal loans allow you to get a lump sum when the loan closes. You can generally use these loan funds from a home equity loan or a personal loan however you want. Home renovation projects, college expenses, consolidating debt, starting a business and other large expenses are common uses for both personal loans and home equity loans.

How Home Equity Loans Work

Home equity loan borrowers receive a lump sum when the loan closes, which can generally be used for anything the borrower wants. A home equity loan does not have to be used to improve your home – instead, it's called a home equity loan because it allows you to borrow from your home's equity, which serves as collateral for the loan.

A home equity loan is considered a mortgage, and if you already have an existing mortgage, your home equity loan will serve as a second mortgage. Typically, you can borrow up to 90% of your home's value, depending on your credit score and the lender you use. Because a home equity loan is secured by your home, its interest rates are generally lower than rates of other loan types, including personal loans.

Quick Facts: Home Equity Loans

Here's a quick look at some of the basics of a home equity loan:

When Home Equity Loans Are A Smart Choice

There are certain circumstances under which a home equity loan can be the right choice for your financial situation. The biggest reason you might choose a home equity loan is if you have significant equity in your home. If you've recently moved into your home or have a high first mortgage amount compared to the value of your home, a home equity loan may not make sense, as there isn't a lot of equity to borrow against.

If, on the other hand, you have lived in your home for a significant amount of time and/or your home's value has rapidly appreciated, a home equity loan can make a lot of sense. You'll have fixed monthly payments, and the interest rate with this type of loan is usually lower as compared to a personal loan. You can use a home equity loan to fund major home improvement projects and other needs.

How To Get A Home Equity Loan

A home equity loan is considered a second mortgage, so the process of getting a home equity loan is similar to that of getting a first mortgage. You'll need to provide documentation of your current financial status, and you can expect to pay closing costs and origination fees. The credit score needed for a home equity loan varies by lender, but often the minimum is around 620. Most importantly, you will need to have a decent amount of equity in your home as most home equity loans limit you to 90% of your home’s value, depending on your credit score, minus any first mortgage amount that you have.

How Personal Loans Work

A personal loan is another form of loan that is commonly used for large and/or unexpected expenses. Being approved for a personal loan will largely depend on your credit score and other financial information. The higher your credit score, the more likely you’ll be approved for a personal loan, and the lower your interest rate. Keep in mind that a personal loan typically has a higher interest rate than a home equity loan because it is usually (but not always) not secured like a home equity loan is.

Quick Facts: Personal Loans

Here's a quick look at some of the basics of a personal loan:

When Personal Loans Are A Smart Choice

There are several reasons why a personal loan can be a good option – chief among them is the flexibility that this kind of loan offers compared to other loan types. The amount of money that you can get with a personal loan may vary depending on your income, credit score and other financial factors. Expenses such as debt consolidation, vacations and weddings are common reasons for taking out a personal loan.

How To Get A Personal Loan

The loan application process to get a personal loan usually involves providing the lender with your basic financial information and approval to pull your credit. Your loan will likely be approved or not based on your credit score, income and debt-to-income ratio (DTI). The amount of time it takes to get a personal loan varies by lender – some lenders are able to give you an approval in a matter of a few minutes.

At A Glance: Personal Loan Or Home Equity Loan

Here's a glance at how personal loans and home equity loans stack up against each other:

Alternative Loan Options For Home Equity And Personal Loans

While home equity and personal loans are popular ways to access cash when you need it, they aren't the only options. You might also a consider home equity line of credit (HELOC), credit cards, cash-out refinances and home improvement loans. Talk with your friends, family or trusted financial advisors to decide which loan option makes the most sense for your specific financial situation.

FAQs: Personal Loan Vs. Home Equity Loan

Is a home equity loan the same as a personal loan?

No, home equity loans and personal loans are two different kinds of financial instruments. A home equity loan is secured by the equity in your home and is usually considered a second mortgage. The amount you can borrow is limited to 80% – 90% of the equity you have – at most. A personal loan is generally unsecured, with amounts, terms and interest rates depending only on your credit score and other financial information.

What is the downside of a home equity loan?

The biggest downside of a home equity loan is that it’s secured by your home. So, if you default on your home equity loan, the bank may foreclose on your home. This means that you could be forced to leave your home.

How much would a $20,000 home equity loan cost per month?

The amount that you would pay per month on a $20,000 home equity loan will vary based on the term of the loan and the interest rate that you receive. As one example, a $20,000 home equity loan with a 9% interest rate and a 10-year term would have a monthly payment of $253.

By the end of the 10-year term, you would have paid a total of $10,402 in interest on top of your $20,000 principal. Therefore, the total cost of the loan would be $30,402.

What should I not use a home equity loan for?

It's generally not ideal to use a home equity loan for discretionary expenses like travel. Instead, it’s better to use the proceeds of a home equity loan to improve your overall financial situation, like starting a business, improving your home's value or consolidating debt.

Can I get a personal loan if I have poor credit?

There are personal loans that are available to people with poor credit, especially if you have a high income or other positive financial assets. However, keep in mind that the lower your credit score, the higher interest rates and fees that you'll likely have to pay.

Can I use a personal loan for medical expenses?

Yes, generally there are no restrictions on what you can use a personal loan for. You'll simply receive a lump sum shortly after closing. That means you can use a personal loan for medical expenses, home improvements, funding a business, emergency expenses or anything else that you want.

Is a home equity line of credit (HELOC) the same as a home equity loan?

No, a HELOC and a home equity loan are not the same thing, though both give you access to money based on the equity in your home. With a home equity loan, you receive a lump sum shortly after closing and you make fixed monthly payments over the term of the loan. A HELOC is more like a credit card, where you can borrow a variable amount of money, placed in a line of credit to draw from when needed during a withdraw period. You only pay interest on the amount of money you've borrowed so far.

The Bottom Line: Pick A Home Equity Loan Or Personal Loan Based On Your Needs

Both a home equity loan and a personal loan can be valid choices when looking to access money for upcoming large and/or unexpected expenses. While a home equity loan may come with lower interest rates, it's also secured by the equity in your home. If you don't have much equity, or if you're worried about losing your home if you default, you might consider a personal loan. Personal loans generally come with higher interest rates than home equity loans, but they are also typically easier to get and are usually unsecured. For help, it’s recommended you speak to a financial advisor.

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