Credible takeaways
- Home equity loans use your home as collateral, meaning it’s at risk if you can’t make payments. Personal loans, meanwhile, are typically unsecured.
- Rates on home equity loans tend to be lower than on personal loans due to decreased risk to the lender.
- A HELOC, cash-out refinance, or credit card may also give you access to the funds you need.
Home equity loans and personal loans are both fixed-rate installment loans that can help you finance large purchases or surprise expenses — pretty much whatever you need them for — but they differ in key ways.
In this article, we’ll dive into those differences, as well as some alternatives, so you can decide what will work best for you.
Key differences between personal loans and home equity loans
Personal loans and home equity loans have quite a few differences, but perhaps the most impactful is that personal loans are unsecured, while home equity loans are backed by your home. This means that it would be at risk if you can’t make payments. Here are some of the other differences:
Reasons to get a personal loan
Personal loans are installment loans with fixed interest rates, usually for smaller amounts and shorter repayment terms than home equity loans.
As mentioned, personal loans tend to be unsecured, meaning that they’re not backed by an asset you own. Instead, lenders decide whether they want to lend to you, how much you can borrow, and the rate they’ll charge you based on your credit score and reports, income, and current debts.
Some of the positives associated with unsecured personal loans include:
- Fast access to funds: Some lenders will be able to get you your money the same business day you’re approved, and it seldom takes more than a few days to receive a personal loan disbursement.
- No risk of losing property: Since personal loans are usually unsecured, you don’t run the risk of losing your home, car, or another asset if you can’t make your payments. But making payments late or defaulting on your loan will still seriously hurt your credit score and future borrowing ability.
Some of the possible downsides include:
- Higher APRs: Because personal loans tend to be unsecured, their interest rates are higher on average than secured loans. If you have fair or poor credit, the rate you're charged could be fairly high. Reputable personal loan rates top out around 36%.
- Smaller amounts: While some lenders set loan maximums of $100,000, many lenders don’t offer loans that large and reserve their top amounts for those with excellent credit and strong incomes. If you need a larger sum of money, a personal loan may not be the best choice.
- Shorter repayment terms: Personal loan repayment timelines are usually shorter than on home equity loans, so you may end up with a larger monthly payment for the same amount of money.
Reasons to get a home equity loan
Home equity loans are secured by your home. Because of this, rates tend to be lower than they are for unsecured loans, such as personal loans, and your credit score may not be as much of a factor in the lender’s decision. But if you don’t make your payments, you could lose your home.
Important
You can calculate your home’s equity by subtracting from its value any money you still owe on all loans secured by it. Lenders generally require you have at least 15% to 20% equity in your home.
Some of the pros associated with home equity loans include:
- Lower rates: You’ll typically pay less interest on a home equity loan than a personal loan.
- Not as dependent on credit score: Because your loan is backed by your home, the lender’s decision won’t be solely based on your credit score.
- Possible tax benefits: If you plan to use your home equity loan on a project that will substantially improve your home, you may be able to claim the interest you pay as a tax deduction.
Some of the more impactful negatives associated with home equity loans include:
- Could lose your home: The worst-case scenario is not being able to make the payments on your home equity loan and losing your home. Make sure you’ll be able to comfortably cover the payments for the life of the loan before you take out a loan secured by home.
- Not having enough equity in your home to qualify for the amount you need: Since most lenders won’t lend you more than 80% of the equity in your home, if you don’t have enough equity, you may not be able to get the amount of money that you need.
- Must pay back in full if you sell: If you sell the home that you used to back your home equity loan, you’ll need to quickly repay the money you borrowed, plus any interest and fees.
Choosing between a personal loan and home equity loan
Here are some of the biggest considerations to keep in mind if you’re choosing between a home equity loan and a personal loan:
- The purpose of the loan: If you’re using the loan for a home improvement project that will add to the value of your home, a home equity loan may be a wise choice, as you may be able to claim the interest you paid as a tax deduction. On the other hand, if you need money quickly, a personal loan could be the better option — disbursement often takes days, whereas a home equity loan can take weeks.
- Your financial situation: If you have a great credit score, you may be able to qualify for a personal loan with a low rate that wouldn’t put you at risk of losing your home. If you have a lower score, a home equity loan may be a wiser choice. Lenders will also look at your debt-to-income ratio to calculate if you can afford to take on more debt.
- How much equity you have in your home: If you have a good deal of equity in your home, it will likely be easier to get the money you need, even if it’s a large amount.
- The cost of borrowing: Compare rates and fee structures on loans to see how much it would cost you to borrow the amount you need — while home equity loan rates can be lower than personal loan rates, that may not always be the case.
- What you can afford: Perhaps most importantly, you should be confident that you can repay whatever loan you take out. The monthly payments on home equity loans are usually lower due to their longer repayment terms, but there are also more severe consequences to not being able to make your payments. Carefully review your budget to make the best choice for you.
Alternatives to personal loans and home equity loans
Maybe neither a personal loan nor a home equity loan is right for you. Here are some other options to consider if you need money.
HELOC
A home equity line of credit, or HELOC, is a loan that is secured by your home’s equity, much like a home equity loan. But HELOCs are revolving credit products, not installment loans.
You’d be approved for a line of credit that you could draw from repeatedly during the draw period, up to a limit, while generally paying only interest. This usually lasts about 10 years, and is followed by a repayment period of around 20 years. HELOCs have variable interest rates, as well as payment amounts that will vary based on your monthly balance.
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Cash-out refinance
If you have equity in your home and an existing mortgage, you may be able to use a cash-out refinance. This involves refinancing your mortgage for a larger amount and taking the difference in cash. Cash-out refinances are usually paid back over a 30-year period.
Credit card
If you need money quickly, a credit card could be an effective alternative to a personal or home equity loan. While rates for credit cards are higher, on average, than on home equity or personal loans, some credit cards offer 0% APR promotional periods. If you can pay off your balance before that period ends and interest kicks in, this can be a good borrowing option.
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Personal loan vs. home equity loan FAQ
Can I sell my home while I have a home equity loan?
Yes, you can sell your home while you have a home equity loan, but you will be expected to immediately pay back the money you owe, plus any applicable interest and fees. If you’re planning to move soon, a personal loan or other alternative may be a better option.
How can I calculate my home equity?
Your home’s equity is its value minus any money you still owe on it. Say your home’s value is $500,000 and you still owe $200,000 on your mortgage. In that case, you’d have $300,000 of equity in your home.
Is it smart to cash out my home equity?
It depends on your situation. Tapping into your home’s equity can be a cost-effective way to finance big expenses, but you could lose your home if you default.
Personal loans can also provide access to a lump sum of cash, and are typically unsecured, but you may pay more to borrow. Whatever you do, make sure you can comfortably make timely monthly payments for the life of the loan.
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