Home Equity Loans vs Personal Loans: Which One Is Right for You?

Q: Do I need collateral to secure a personal loan or a home equity loan?

You do not need collateral to secure a personal loan. With a home equity loan, your home is used as collateral. This can allow you to qualify for a lower interest rate, however, if you fail to make your payments, you are at risk of losing your home.

Q: How does my credit score affect my eligibility for a personal loan or a home equity loan?

Your credit score plays a role in whether or not you’ll qualify for a personal loan or a home equity loan. However, there are lenders that do offer personal loans to those with poor credit. To reduce the risk to the lender, you’ll typically be charged a higher interest rate or be asked to put up collateral.

Q: What happens if I default on a personal loan compared to a home equity loan?

If you default on any type of loan, your credit score will take a hit. With a personal loan, you could be sent to collections, your wages could be garnished, and you could face a lawsuit. With a home equity loan, you risk losing your house, as the lender would have the right to seize the home in the event of default. Prior to taking out any type of loan, it’s important you have a plan in place to pay it back to prevent default from happening.

Q: Can I use a personal loan to purchase a home instead of a traditional mortgage?

Technically, you can use a personal loan to purchase a house. However, this is not ideal. Personal loans usually max out at $100,000, and interest rates are higher than traditional mortgages. Terms are also much shorter, so you’ll be expected to pay the loan back within five years as opposed to 30 years with a traditional mortgage.

Q: Can I refinance my personal loan into a home equity loan?

Yes, but the way to do this would be to take out a home equity loan and then pay off the personal loan. This could be a great way to save on interest costs, as home equity loans typically come with lower rates than personal loans.

Home Equity Loans vs Personal Loans: Pros and Cons Comparison

Kevin BrouillardUpdated September 28, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

When you need to borrow money, knowing where to start can be challenging. Personal loans and home equity loans are both options to get lump-sum financing for a range of uses, such as emergency expenses, home improvement projects, and debt consolidation. If you’re deciding between a home equity loan vs a personal loan, it’s important to consider what you’re financing and your personal situation with money. Here’s what you need to know about home equity loans vs personal loans, including loan requirements, pros and cons, and scenarios when each loan type could be a better choice.

What Is a Personal Loan?

A personal loan gives borrowers flexible funding to use for a variety of purposes, such as medical bills, a wedding, or unexpected expenses. Personal loans can be taken out from banks, online lenders, and credit unions. This type of financing is usually repaid at a fixed rate over time and has a specific end date. Borrowers may choose between secured and unsecured personal loans. A secured personal loan involves collateral, such as a savings account or a vehicle, as a condition to borrowing. Lenders may claim the asset to pay off the debt if a borrower defaults on a personal loan with collateral. Meanwhile, unsecured personal loans do not require any collateral. Given the greater risk to the lender, unsecured personal loans often carry higher interest rates.

Requirements for a Personal Loan

Requirements for a personal loan can differ by lender, but there are some common financial factors they consider when reviewing borrowers. With any loan, lenders will evaluate a borrower’s payment history and creditworthiness. Having a lower credit score could result in a higher interest rate on a personal loan. Some lenders may have a minimum credit score to qualify, while others may lend to borrowers with limited or no credit history. In addition to credit history, lenders will evaluate borrowers’ debt-to-income ratio (DTI) — the percentage of gross monthly income that goes toward debt payments each month. Each loan you take out raises your DTI.Borrowers with existing debt may be wondering how many personal loans you can have at the same time. While there is not a formal limit, lenders may up the loan’s interest rate or reject a second personal loan application based on the impact to your DTI. Recommended: Types of Personal Loans

Typical Personal Loan Terms

Personal loan terms determine how much time you have to repay the loan, as well as the interest rate and any fees you could be charged to borrow. With personal loans, borrowers may take out up to $100,000 depending on qualifications and the lender. However, the average unsecured personal loan was $11,548 in the second quarter of 2023. Borrowers can choose from repayment terms of 12 to 60 months, on average. Extending the term length can allow for smaller monthly payments, but more interest is paid in the long run. The average interest rate on a 24-month personal loan was 11.48% in the second quarter of 2023, according to Federal Reserve data. Personal loan lenders may also charge fees, such as origination or application fees, which are reflected in the APR. These costs can either be tacked on the loan balance or deducted when the loan is disbursed.

What Is a Home Equity Loan?

For many people, their home is their most valuable asset. A home equity loan, also known as an equity loan or second mortgage, lets homeowners use the equity in their home as collateral to borrow money. Home equity represents the difference between a home’s value and how much is still owed on the mortgage. The loan amount is based on this value, with lenders typically limiting borrowers to a certain percentage of the equity accumulated. Building equity can take years, depending on how quickly you pay down your mortgage and how much your home value increases over time.

Requirements for a Home Equity Loan

What you need to qualify for a home equity loan can vary by lender. Like personal loans, home equity loan eligibility is impacted by a borrower’s credit score and debt-to-income ratio. Often, lenders require a debt-to-income ratio of 43% or less to qualify for a home equity loan. A key difference between a home equity loan vs a personal loan is that the amount you can borrow is constrained by how much equity you have. Lenders can require a minimum amount of equity — usually at least 15% — to qualify for a home equity loan. To determine qualifications and loan amount, lenders may require proof of income and an appraisal to verify the home’s fair market value.

Typical Home Equity Loan Terms

Home equity loan terms are similar to a home loan, hence being called a second mortgage. Funds are generally issued as a lump sum with fixed-rate monthly payments, meaning that the interest rate stays the same over the life of the loan. With home equity loans, the amount you can borrow is calculated as a percentage (often up to 85%) of the total value of the home minus the mortgage debt. As of 2023, the average American homeowner has $274,000 in home equity. Based on that number, they could qualify for a home equity loan over $232,000, depending on other eligibility requirements. Like a mortgage, repayment terms may extend as long as 30 years, though repayment periods of five to 15 years are also possible. Using a home equity loan instead of a personal loan to get the money you need could give you a longer loan term.

Pros and Cons of Home Equity and Personal Loans

Both loan types are typically fixed-rate, lump-sum financing options that offer flexibility for how borrowed money is spent. Still, there are some key differences, especially when comparing the benefits and drawbacks of a personal loan vs. home equity loan:

Home Equity Loan Pros	Home Equity Loan Cons
Interest rates are usually lower than credit cards or personal loans.	Your lender could foreclose on your home if you enter into default.
Greater flexibility in loan terms and repayment options.	You could end up owing more than your home is worth if real estate values decrease.
Interest can be tax deductible if the loan is used for home improvements.	Can have high fees and closing costs.

Personal Loan Pros	Personal Loan Cons
Offer flexible borrowing amounts, especially for smaller loans.	Unsecured personal loans typically have higher interest rates.
No risk of home repossession.	May require collateral for borrowers with lower credit.
Provides faster access to funds.	Can come with high origination fees.

When to Consider a Home Equity Loan

There are certain situations that favor a home equity loan vs a personal loan. For instance, the collateral of a home can secure lower interest rates and help borrowers with subpar credit qualify for financing. Thus, home equity loans are worth considering as debt consolidation loans for homeowners with high-interest debts.If you need to take out a sizable amount, home equity could be leveraged to borrow more money than personal loans might allow. This is especially the case for borrowers who have built up a large amount of equity in their home. If you’re in the market for home improvement loans, a home equity loan can give the added advantage of tax benefits. If funds are used for home renovations, the interest paid on the loan is an eligible tax deduction. Recommended: What Are Retiree Loans?

When to Consider a Personal Loan

Opting for personal loans vs home equity loans could be a better fit for some borrowers. If you don’t have much home equity, a personal loan may allow you to borrow more money. Personal loans can usually be processed faster than home equity loans, which typically require a home appraisal for the loan’s collateral. When confronted with emergency expenses, quick personal loans could help secure necessary funds while offering peace of mind. This type of personal loan is offered by a variety of online lenders.

Weighing Which One to Choose

There is no one-size-fits-all financing option. Choosing between a home equity loan vs a personal loan will depend on your own financial situation and what the funding will be used for. With either loan type, it’s recommended to consider the loan terms, including interest rate, fees, and repayment period before borrowing.

Comparison of Interest Rates and Terms

Personal loans had an average interest rate of 11.48% in the second quarter of 2023, whereas home equity loan interest rates averaged 8.61% in September of 2023.Terms will also vary between personal loans and home equity loans. Personal loan terms are typically capped at five years, whereas home equity loan terms can extend to 30 years. Having a longer loan term can make your monthly payments smaller, but keep in mind you will pay more in interest over the life of the loan.

Eligibility and Approval Process

Getting a personal loan is usually an easier process than getting a home equity loan. For a personal loan, you can qualify online and get preapproved almost instantly. If you decide to move forward, you could be funded within 24 hours of final loan approval.A home equity loan has a more extensive approval process because you’re using your home as collateral. Your lender will typically request an appraisal, which can take weeks to complete. There’s also more paperwork involved with home equity loans than with personal loans.Both types of loans want to see good credit scores and stable income in order to get the best rates. With a home equity loan, you’ll also need to have at least 15% equity in your home in order to qualify.

Risk and Collateral Considerations

Home equity loans come with greater risk than personal loans. If you default on a home equity loan, you could potentially lose your home. If you default on either a personal loan or a home equity loan, your credit score could take a major hit. Defaulting on a loan can also make it much harder to get approved for financing down the line. With either type of loan, make sure you can comfortably afford the monthly payment before deciding to take on additional debt.

Alternatives to Personal Loans and Home Equity Loans

If neither a personal loan nor a home equity loan sounds like a good option for you, there are other financing alternatives to consider. These include:

Home Improvement Loans

If you’re looking to update or renovate your home, you may be interested in a home improvement loan. A home improvement loan is actually just a personal loan, but is used to make repairs or updates on your home. Interest rates on home improvement loans, like personal loans, are higher than with home equity loans. If you qualify, the maximum amount is usually $100,000 and terms are typically five years.If you need more than $100,000 to update your home or want a longer term, consider a home equity loan, instead. You can use a home equity loan to make improvements on your home, so long as you have equity in your home available and you meet the lender’s requirements.

Credit Cards

You can use a credit card in place of a loan to consolidate debt or handle certain expenses. A notable benefit is that credit cards allow for interest-free purchases, often tied to a promotional period or if you pay off your balance in full each month. Also, many credit cards offer cash back rewards and points on purchases. Keep in mind that credit cards come with drawbacks, too. Late payments can hurt your credit score, and balance transfers and cash advances can carry high interest rates and fees. Also, if you don’t pay your balance in full each month, the interest rate will typically be much higher than with other forms of financing.

Home Equity Line of Credit

A home equity line of credit (HELOC) lets homeowners borrow against the equity in their home.Compared to home equity loans, however, HELOCs differ in that you have the flexibility to borrow money multiple times from an available credit limit set by a lender. Borrowers may make payments on withdrawals to replenish funds or wait until the draw period (usually 10 years) ends to begin repayment.With a home equity line of credit, terms often include a variable interest rate, meaning it can fluctuate during the repayment period. Recommended: Personal Line of Credit vs. HELOC

The Takeaway

Personal loans and home equity loans can both be solid forms of borrowing, and which one you choose will depend on your needs and your qualifications. Home equity loans typically come with lower interest rates and longer terms, but you need to have at least 15% equity in your home in order to qualify. Your home is also used as collateral with this type of financing, so if you default, you are at risk of losing your home.A personal loan, on the other hand, is typically a much faster process than getting a home equity loan. Interest rates, however, are higher and loan terms are shorter. If you need cash quickly, a personal loan may be best for you.If you've decided a personal loan is right for your needs, compare personal loan rates with Lantern by SoFi to help you find a lender. Lantern allows you to shop multiple lenders with just a single application and no obligation to you.

Frequently Asked Questions

Do I need collateral to secure a personal loan or a home equity loan?

How does my credit score affect my eligibility for a personal loan or a home equity loan?

What happens if I default on a personal loan compared to a home equity loan?

Can I use a personal loan to purchase a home instead of a traditional mortgage?

Can I refinance my personal loan into a home equity loan?

Photo credit: iStock/kate_sept2004

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About the Author

Kevin Brouillard

Kevin Brouillard is a Returned Peace Corps Volunteer, educator, and personal finance writer. His work has appeared in online publications such as Earth Island Journal, Jetsetter, Oyster.com, and Tripsavvy. Kevin covers an array of financial topics for SoFi, including loans for students and small businesses.

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