Home Equity Loan vs. Personal Loan: How They Compare
Whether you want to consolidate debt, finance a major expense or access funds for another financial need, both a home equity loan and a personal loan could work. Both loan types typically come with fixed interest rates and fixed payments over a set repayment term.
However, there are stark differences you’ll need to consider when comparing home equity loans versus personal loans.
- Home equity loans vs. personal loans
- Should you choose a home equity loan or personal loan? Answer these questions first
- How to get a home equity loan or personal loan
Home equity loans vs. personal loans
The average interest rate on a 15-year fixed-rate home equity loan is 5.76%. However, the interest rate may be higher or lower depending on your credit history, income, overall debt load, the loan-to-value ratio on your first mortgage and other factors. Common fees include:
- Origination fees
- Appraisal fees
- Recording fees
- Prepaid interest (points)
Personal loans tend to have higher interest rates compared with home equity loans because they aren’t backed by collateral, which means they are riskier for lenders. The average interest rate on a personal loan is 11.15%. In addition to paying the interest rate, you may have to pay an origination fee ranging from 1%-6% of the loan amount.
Personal loan repayment terms typically range from two to seven years. Outlier lenders such as LightStream can issue personal loans with terms topping out at 12 years. For longer-term borrowing, a home equity loan likely makes more sense. These have terms ranging from five to 30 years. But if you sell your home before the term is up, you’ll need to pay off the loan in full with the proceeds of the sale.
Home equity loan borrowing amounts are usually limited to 85% of the equity you have in your home. But other factors such as your income, credit history and the value of your home can come into play. That said, borrowing limits could be up to hundreds of thousands of dollars if you have the equity and income to repay the loan.
For personal loans, borrowing limits can be much smaller, especially if you have less-than-perfect credit. A typical personal loan could have a limit of $5,000 to $50,000. But some lenders offer up to $100,000.
Requirements for borrowing
If you’re considering a home equity loan, the lender may care a lot about your debt-to-income ratio. This compares your total debt load (including mortgages, student loans, etc.) to your monthly income. Home equity lenders may want your DTI to be below 43%. If you have a good credit score, you’re likely to be approved for a home equity loan. (You can learn more about requirements here.)
Requirements for personal loans vary depending on the lender. The lowest interest rates are often reserved for borrowers with excellent credit and a good source of income.
Should you choose a home equity loan or personal loan? Answer these questions first
- Do you feel comfortable using your house as collateral?
- Do you have strong credit?
- How much home equity do you have, and is it ‘tappable?’
- How long and how much do you need to borrow?
- How soon do you need loan funds?
- Can you afford the monthly payment?
1. Do you feel comfortable using your house as collateral?
When you take out a home equity loan, you’re using your house as collateral. Missing payments on the loan could lead to foreclosure. If you don’t want to put your house at risk, consider a personal loan instead.
2. Do you have strong credit?
If you’ve got excellent credit, you may be able to take out a personal loan with interest rates as low as 4.99%. That interest rate is over 2 percentage points higher than the lowest interest rate on home equity loans, which carry a 2.75% interest rate for a 5-year term.
But borrowers with moderate or poor credit scores may see much higher interest rates on personal loans. The higher interest rates are intended to offset the risk your lender would take in offering you an unsecured loan. Borrowers who don’t have strong credit but who can tap their home equity can save a lot of money by choosing a home equity loan over a personal loan.
3. How much home equity do you have, and is it ‘tappable?’
If you own a house that is worth $200,000 but you only owe $100,000 on the mortgage, your home has $100,000 of equity. Tappable equity, however, is the equity you can borrow against.
Lenders often require borrowers to keep a loan-to-value ratio below 85%. In the above scenario, you’d have $100,000 of equity but not all of it can be tapped. If the lender requires borrowers to keep a loan-to-value ratio of 85%, you could only borrow a total of $170,000 between both mortgages. That’d leave you with $70,000 of tappable equity.
If you don’t have tappable home equity, a home equity loan won’t be an option for you.
4. How long and how much do you need to borrow?
With a home equity loan, you may qualify to borrow much more money and for much longer than with a personal loan. If you have a big and expensive project, like an extensive home remodeling project, a home equity loan with a 15- or 30-year repayment term could make a lot more sense than a personal loan with a 3- or 5-year term.
If you only need to borrow a small amount of money, or you’d prefer a shorter repayment term to ensure you get out of debt fast, a personal loan could make more sense.
You should also consider how you plan to use your loan funds. Ask yourself whether using your home as collateral is worth the purchases you’re planning.
5. How soon do you need loan funds?
Some personal loan lenders can release funds the same business day your application is approved. For home equity loans, it can take a couple weeks or longer to close a home equity loan. So if you’re in need of fast funds, a personal loan may be the only viable choice between these two options.
6. Can you afford the monthly payment?
Whether you choose a home equity loan or a personal loan, you need to be able to cover the monthly payment. In general, home equity loans will tend to have lower monthly payments compared with personal loans due to their longer repayment terms.
Make sure you’ll have enough cash flow each month to make on-time payments. Ideally, you should also have an emergency fund to rely on if you fall on hard financial times.
How to get a home equity loan or personal loan
Applying for a home equity loan
- Check your credit score. Before applying for a loan, you need to know your credit score. A higher credit score should improve the likelihood that you’ll find a competitive interest rate on your home equity loan.
- Request quotes from at least three lenders. Whenever you take out a loan, you want lenders to compete for your business. Lenders may request more information from you before they offer a rate.
- Negotiate. Once you see quotes from lenders, negotiate. Lenders may reduce or eliminate origination fees, offer lower interest rates or eliminate points (prepaid interest) when they know you’re working with multiple lenders.
- Sign the papers with a loan officer. When you’re happy with the loan offer, work with the lender to set a closing date. In most cases, you’ll sign your loan documents in person. However, lenders in some states may allow you to sign your mortgage digitally. Whether you sign online or in person you may want to choose to have an attorney read over the documents before you sign them. Once you sign papers, you will receive the loan proceeds in your bank account.
Applying for a personal loan
- Check your credit score. Knowing your credit scores will help you see yourself the way a lender sees you. Higher credit scores will usually mean lower interest rates.
- Compare rates from at least three lenders. Today, it is easy to request free rate quotes from online personal loan lenders. Many of the top lenders will even use a soft credit pull to estimate a loan rate before you officially apply. A soft credit inquiry will not hurt your credit score. Compare quotes from multiple lenders before you decide to formally apply for a loan.
- Complete a formal application. Many lenders will allow you to sign personal loan documents online. But you may also have to provide additional documentation as part of your application. Loan funds may be transferred to your bank account as soon as the same day you formally apply.
When you need a loan with a moderate interest rate, both a home equity loan and a personal loan could make sense in your circumstances. Be sure to compare a home equity loan versus a personal loan before you decide which is best for you.