Updated – December 6, 2018
For homeowners in need of some financial flexibility, a personal loan or a home equity loan can provide extra cash for financing an education, dealing with an unexpected emergency, or making home improvements. Both loan types offer different benefits as well as different risks, so it’s important to weigh your options before borrowing.
Personal loan vs. home equity loan
Personal loans and home equity loans offer different options for customers who need access to a larger amount of cash than they have on hand. While the end result of a successful application is the same (ready access to funds in a lump-sum payment), the process and the finer details are considerably different.
The primary difference between a personal loan and a home equity loan is that personal loans do not typically require collateral, whereas a home equity loan does. You may have heard lenders call this type of financing a signature loan or unsecured loan because in these types of transactions, your word is your bond (via a legally-binding contract, of course.)
Home equity loans are based on the amount of equity (the difference between what you owe and the value of your property) you have in your house. There are a few other differences regarding how the loan is structured and the loan cost, which is detailed in the chart below.
|Personal loan||Home equity loan|
As low as 3.49%
4.25% to 6%
There may be some fees, such as an origination fee or prepayment penalties.
In addition to a loan origination fee, borrowers may have to pay an appraisal fee, title report fee and notary fee.
How much money can you borrow?
The amount is based on your income and credit history.
The amount is based on the equity in your home. Typically maxes out at 70% to 80% or total loan to value.
Restrictions on use
Only if you care about a tax write-off.
Yes. If the money is used to make improvements to the home.
Rates sourced from LendingTree.com, which owns MagnifyMoney.
How personal loans work
When you take out a personal loan, the lender offers a lump-sum cash payment. Most personal loans can be used for anything you want. Common uses include:
Talk with your lender to find out if they have specific procedures for handling this type of personal loan.
Personal loans are widely available. It is imperative that you take your time doing research. Some of the personal loans you’ll find online may be nothing more than payday loans in disguise (with interest rates that can creep into triple digits).
If you want the best rates, you should work with a trusted lender. Many banks, credit unions and credit card companies even offer an online application process, so you can take advantage of the convenience of an online application while saving money.
As low as 3.49%
Minimum 500 FICO®
24 to 60
LendingTree is our parent company. LendingTree is unique in that you may be able to compare up to five personal loan offers within minutes. Everything is done online and you may be pre-qualified by lenders without impacting your credit score. LendingTree is not a lender.
As of 17-May-19, LendingTree Personal Loan consumers were seeing match rates as low as 3.49% (3.49% APR) on a $10,000 loan amount for a term of three (3) years. Rates and APRs were based on a self-identified credit score of 700 or higher, zero down payment, origination fees of $0 to $100 (depending on loan amount and term selected).
Interest rates vary from lender to lender, but they also vary from state to state. State usury laws dictate the maximum interest rates on various loan types, but each state offers different exemptions. For example, Arkansas caps interest rates on consumer loans at 17% per year, but in Utah, the legal rate is 10%, unless parties agree to different terms. For this reason, make sure you take the time to read the details of any financial agreement you are prepared to sign.
According to the Federal Reserve, personal loan interest rates averaged 10.1% at the end of August. Your credit score, loan amount, home state and credit history could affect those numbers.
As mentioned earlier, most personal loans don’t require collateral, but lenders make up for the added risk with higher interest rates than you’ll typically find on home equity loans.
Unsecured personal loans are a little harder to get than other types of loans (such as a title loan or a home equity loan) because the lender is allowing you to borrow money based solely on the information they get about you. If you have a lot of debt or a very low credit score, you may find it difficult to get a personal loan, or you’ll have to consider a higher interest rate.
Terms and fees
For true personal loans, expect loan terms up to five years. Personal loans are also fixed rate, which means your interest rate (and your payment) will stay the same throughout the life of the loan.
Some lenders charge an origination fee, loan insurance and/or prepayment penalties. Make sure to talk to your lender about their specific requirements before moving forward.
The application process is fairly straightforward. You’ll fill out some personal information and provide financial documents to show you can afford the monthly payments. Depending on your lender and the type of loan you are seeking, you could have access to the money in as little as 24 hours, though some loans could take up to a week.
Personal loans are a good option for borrowers who need access to cash fairly quickly but don’t have home equity and/or don’t want to pay the higher interest rates on most credit cards.
No collateral required
Slightly higher interest rates
Easy application process
Tougher credit history requirements
Lots of lenders available
Potential to run into very unfavorable terms
Cash available within a day or two
Average loan amounts are fairly low
How home equity loans work
A home equity loan operates differently than a personal loan because the lender looks at how much equity you have in your property. Then, they do a little number magic and offer a loan amount based on the loan-to-value rate.
One of the biggest benefits of a home equity loan is that it can provide access to a large sum of money. The equity of your home is determined by calculating the home’s current market value and subtracting any liens against the property (like your mortgage). If you purchased a home for $350,000 and still owe $100,000 on the property and you have no other liens (such as a second mortgage), your equity would be $250,000. If you run up against a major emergency, access to this type of money could very valuable.
To qualify for a home equity loan there are two major requirements:
- You must own a home.
- You must have equity in that home.
Your lender will check your payment history and some other financial information as well.
Documents you may be required to provide include:
- Proof you own the home
- Pay stubs and/or two years of tax returns
- Tax assessments
- Mortgage statements
- List of debts (if using the money to consolidate your bills)
- A form showing the value of your home
Borrowers should know that the maximum lenders will allow you to borrow is typically 85-90% of your equity. (So if you have $100,000 in equity, the most lenders would allow you to take out is $85,000-90,000, though many lenders prefer closer to 80% or less.)
A major drawback for this type of loan is that you are using your home as collateral. That means if you are unable to make your payments, you could lose your house. Another risk is that your home could drop in value, putting you underwater on your property.
Home equity loans may offer lower interest rates (because you are putting your home up as collateral, there is less risk for the lender), but they often come with closing costs and loan origination fees, which can eat into your borrowing power.
Like personal loans, home equity loans have a fixed-interest rate, which means you’ll know how much you have to pay every month for the term of your loan. A home equity loan provides a lump-sum payment (like a personal loan). Home equity loans tend to have slightly longer terms than personal loans (between five and 15 years).
Be aware that a home equity loan and a home equity line of credit are similar, but not the same, so make sure you know which one you are applying for if you decide to move forward.
Terms and fees
Some fees you may see when applying for a home equity loan include an appraisal fee (lenders use an appraiser for a more accurate home value estimate.) The fee will vary based on your lender but can cost between $300 and $400.
Your lender may also charge a title search fee (around $100), a credit report fee, lawyer and documentation fees and notary fees. Many lenders charge an origination fee, but some will waive this charge. These little fees can easily add up to $1,000 or more.
Money from a home equity loan can be used for any purpose from medical expenses to home repairs. However, recent tax changes made the tax incentives on these types of loans a little less attractive for borrowers.
The new rules stipulate that in order to qualify for tax deductions, the money must be used to substantially improve a property. Further, since tax deductions increased, you may not even need to itemize your deductions.
Homeowners can apply for a home equity loan through their original lender, but it’s not a requirement. The Federal Trade Commission recommends talking to several lenders and trying to get the best deal by letting them know you’re shopping around.
If you decide after signing for a home equity loan that you’ve changed your mind, federal law provides a three-day grace period where a borrower can cancel the agreement without a penalty. You’ll have to submit the notice in writing.
A home equity loan will take longer than a personal loan (typically two to four weeks). The timeline is longer because the loan process is more complex.
Borrowers who need access to a large amount of money and/or want to take advantage of some of the tax benefits may find the home equity loan attractive. Since this type of loan puts your house at risk, make sure to do the proper research and really study your finances to determine if this type of loan works for you.
Potential for access to a lot of credit
Takes 2 to 4 weeks to get funds
Lower interest rates than credit card or personal loan
More expensive upfront costs
Fixed interest rates
Your home is collateral
There are potential tax benefits for a home equity loan
The tax restrictions only apply to funds used to make significant improvements on the home.
Personal loan vs. home equity loan: Which is better?
There are benefits and risks to both a personal loan and a home equity loan. For borrowers who have a lot of equity in their home and know they can make the loan payments in addition to their mortgage payments, a home equity loan offers lower interest rates, which could mean lower payments and a lower loan cost over time. However, if you are uncomfortable putting your home up as collateral, can’t afford the upfront costs of a home equity loan or don’t need access to a lot of cash, a personal loan may be a better option.
No matter what you choose, make sure to ask your lender a lot of questions and don’t be afraid to shop around to get the best deal.