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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 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 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. For instance, personal loans could be used for 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 by 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. So are personal loans bad for borrowers with fair to low credit scores? 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 can you 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.
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 $7,168 in the third quarter of 2021. Borrowers can choose from repayment terms between 12 to 60 months, or even longer in some cases. 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 ranged from 9.39% to 9.58% in 2021, 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 their equity in a 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. For the average American homeowner in 2021 with $153,000 in home equity, they could qualify for a home equity loan over $130,000, depending on other eligibility requirements. Like a mortgage, repayment terms may extend as long as 30 years, though repayment periods between five to 15 years are also possible. Using home equity vs personal loans to get the money you need could give a longer loan term.
Pros and Cons of Home Equity and Personal Loans Both loan types are 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.
|Pros of Home Equity Loans||Cons of Home Equity Loans|
|Pros of Personal Lines of Credit||Cons of Personal Lines of Credit|
|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 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 also 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.
When to Consider a Personal LoanOpting for personal loans vs home equity loans could be a better fit for some borrowers. If you don’t have much home equity yet, 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 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.
Alternatives to Personal Loans and Home Equity LoansOther funding paths exist as well.
Credit Cards You can use a credit card in place of a loan to consolidate debts 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. For instance, late payments can hurt your credit score and balance transfers and cash advances can carry high interest rates and fees.
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 vs personal loan, or a home equity loan, terms often include a variable interest rate, meaning it can fluctuate during the repayment period.
Explore Personal Loan Rates There’s a lot to factor in when weighing different types of loans. 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. That way, you can find a financing option that works best for your needs. Find your personal loan rate with just a few clicks.
Photo credit: iStock/kate_sept2004
About the Author
Kevin BrouillardKevin 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.