Home Equity Loan vs. Personal Loan: Which One Is Right For You?

Whether you need funds to pay for an unexpected emergency, home repairs or upgrades, or something else entirely, a personal loan and a home equity loan are two popular financing options. Each type of loan has its pros and cons as well as scenarios in which, based on individual circumstances, one is a better choice than the other. Before you make any financial decisions, do your research on the difference between personal loans and home equity loans

What Are Personal Loans?

Typically, a personal loan is an unsecured loan, meaning you do not have to put up collateral. However, in some cases, your bank account might serve as collateral. You receive the money up front and make fixed payments over time. The interest rate tends to be better than a credit card’s but not as desirable as that of a home or an auto loan. Most personal loan repayment terms come in the one- to five-year range. Usually, individuals seek these loans for consolidating debt, funding home improvements, paying unexpected expenses, or making large purchases.

The primary qualifications for personal loans include your credit score and your ability to pay back the loan. The better your credit score, the better your odds of getting approved, and your rates will improve accordingly. The application process should be reasonably straightforward.

What Are Home Equity Loans?

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Home equity refers to the difference between the current value of your property and the current balance of all applicable mortgages. The equity you’ve established in your home is the collateral for a home equity loan or home equity line of credit (HELOC). Similar to a personal loan, you receive the money upfront and pay it back over time, typically at a fixed interest rate.

Because these loans use your equity as collateral and are based on your home’s value, they’re often referred to as second mortgages. The lender will follow many of the same steps it would with a mortgage, such as ordering an appraisal. There will also be associated fees and closing costs, so shop around to find the best rates. Because the loan involves collateral, the interest rates will typically be lower than those of unsecured loans, such as personal loans.

Home equity loans also tend to have longer terms, usually in the five- to 30-year range. In addition to your equity, income, and credit score, lenders will consider the loan-to-value ratio (LTV). They calculate LTV by adding the original mortgage to any equity loans as a percentage of the home’s current market value. The interest rate tends to be proportional to the LTV, meaning the lower the LTV, the lower the lender’s risk. Home equity loans are available for nearly any purpose, with few limitations.

Reasons to Choose a Personal Loan

If you have a high income and strong credit history and want to obtain money quickly, a personal loan might be the best choice. If you have little to no equity in your home, a personal loan might be your only option.

If the home prices in your area are declining, your combined mortgage and home equity loans could potentially exceed the value of your home. The approval process for personal loans tends to be significantly shorter than a home equity loan’s approval process, which can take a month or more. If your need is time-sensitive, a personal loan is likely the better choice.

If the amount you wish to borrow is relatively small, you might not want to go through the process of obtaining a home equity loan. A personal loan offers you the opportunity to access funds with less paperwork and fewer closing costs. Some lenders even have minimum amounts you must borrow before qualifying for a home equity loan.

Also consider that with a personal loan, your home is not at risk. If you are forced to default on a personal loan, your credit score will take a hit, but you won’t lose your home. Therefore, if the funds are for a risky venture such as starting a business, a personal loan’s lower risk threshold might be more attractive to you.

Reasons to Choose a Home Equity Loan

A home equity loan is the perfect choice if you have built significant equity in your home. A home equity loan’s terms are often much more flexible than personal loan terms. For example, personal loans are seldom more than five years, whereas a home equity loan can be as long as 30 years. For large sums, this makes payments much more manageable. Maximum home equity loan amounts typically are more significant than what you could qualify for with a personal loan — another advantage if you wish to borrow a large sum.

Because your home’s equity secures the home equity loan, interest rates are going to be significantly lower than personal loan interest rates. Consider this when calculating how much money you will ultimately pay back with a home equity loan vs. personal loan. You could potentially save thousands of dollars over the loan term with a lower interest rate. Further, you can sometimes use home equity loan interest as a tax deduction, something you can’t do with interest paid on a personal loan.

Final Thoughts

It can be difficult to decide between these two options. Both give you access to funds for a variety of purposes. If you’re borrowing a small amount or don’t want to deal with the hassle that comes with a home equity loan, then a personal loan might be the right choice. If you have a good equity base and can wait the extra time it takes to finalize a home equity loan, that might be your best bet.

Point provides another possibility that will get you money now in exchange for a percentage of your home’s future appreciation. A home equity investment with Point has no monthly payments, and you can sell your home or buy Point out whenever you want during the flexible 30-year term. The costs are also capped, so if your home’s value increases substantially, you won’t forfeit as much of the profit. Check out your pricing today and see if a home equity investment is right for you.

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