Which is Better: A Personal Loan or a Home Equity Loan?

Personal loans and home equity loans can both be used for anything you please. Perhaps you're hoping to pay for a wedding, go on your dream vacation, pay for home improvements, or even consolidate some of your debt. If so, both a personal loan and a home equity loan can meet your needs. But which is better? The answer will, of course, depend on your unique financial situation.

What is a Personal Loan?

A personal loan allows borrowers to access money without having to put up collateral. Also known as an unsecured loan, personal loans are appealing because the interest rates are typically lower than with a credit card. Personal loan amounts range from $1,000 all the way up to $100,000, depending on your income and monthly debt obligations. To qualify for the best interest rates, you'll need to have outstanding credit. You can improve your credit score by paying all of your bills on time, eliminating debt obligations by paying it off, keeping your credit card balances low (or paid off) and removing any old inquiries from your credit report.

Related: 5 Simple Ways to Improve Your Credit Rating

What is a Home Equity Loan?

A home equity loan is a loan that allows homeowners to borrow against the equity built up in their homes. To calculate how much equity you have in your home, subtract the balance of your mortgage from the fair market value of the home, which is determined by an appraisal. While home equity loan interest rates are typically lower than personal loan rates (since the loan is backed by your house as collateral), you need to own your home and have equity in it in order to qualify. Also, the amount in which you can borrow is capped by the amount of equity in your home, keeping in mind that borrowers will only lend you roughly 85 percent of the equity in the home.

Which is Better?

There are a few questions you can ask to help determine whether a personal loan or a home equity loan is right for you:

Do you need the money fast?

A personal loan can be approved within the same day you apply for one and you can normally have your money within one week. A home equity loan, on the other hand, can take much longer. The process is similar to applying for a mortgage—you'll need to submit income documents and tax returns, have your home appraised, and the application will have to go through an underwriter for review, which can take as long as a month.

Do you have equity in your home?

For new homeowners, a home equity loan might not even be an option. In order to get a home equity loan, lenders will want you to have at least an 85 percent loan-to-value ratio after you take out the home equity loan. For example, say your home is worth $300,000 and you owe $200,000 on it. Your loan-to-value ratio of 85 percent is $255,000, meaning you could take out a home equity loan in the amount of $55,000, not $100,000, even though you do have $100,000 equity in the home.

How much money do you need?

If you need less than $10,000, a personal loan could be the way to go as lenders do not always want to deal with home equity loans for small amounts of money (though the minimum amount does vary from lender to lender).

If you've built up substantial equity in your home and you need a large amount of money, a home equity loan could be your best bet since rates are typically lower and the interest payments can be tax deductible. If, however, you only need to borrow a small amount of money or you're a new homeowner, a personal loan could be the best option for you. Whichever route you decide to go, make sure you have a plan in place to pay back the debt.

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