What is the difference between a home equity loan and a personal loan?
Both a home equity loan and a personal loan offer one-time, lump-sum payments that must be repaid in installments over an agreed-upon period of time. However, the main difference is that home equity loans are a specific form of secured loan in which the borrower’s home is used as collateral. Personal loans, on the other hand, can be secured or unsecured, and are a much broader and more varied category.
Since personal loans tend to have a less intensive approval process than a home equity loan, they can usually be obtained more quickly and easily. While home equity loans generally take longer to approve, they tend to offer a lower interest rate than a personal loan and potentially a higher loan amount as well. However, before choosing either option, it is important to consider the amount you need and the intended purpose of your loan.
key takeaways
- Both home equity loans and personal loans offer one-time, lump-sum payments to be repaid in installments over a specified period of time.
- A home equity loan is a type of secured loan in which the borrower’s home is used as collateral, while personal loans can be secured or unsecured.
- Personal loans tend to be quicker and easier to approve, while home equity loans require a property appraisal and a longer application and approval process.
- Home equity loans typically offer a lower interest rate than personal loans, but both typically offer lower interest rates than credit cards.
- Both types of loans can be used for a variety of purposes, although home equity loans can offer larger amounts, depending on the equity in the borrower’s home.
- Interest payments on personal loans are not tax deductible, while interest payments on home equity may be if the loan is used to “purchase, build, or substantially improve the home of the taxpayer securing the loan” .
Structure and purpose of the loan
In a home equity loan, money is borrowed using the value of your home (more specifically, the home equity) as collateral. The FTC defines home equity as “the difference between what you owe on your mortgage and how much money you could get for your home if you sold it.” This is why a home equity loan is sometimes called a “second mortgage.”
Many personal loans are unsecured, but there are secured personal loans available that can be backed by collateral such as a certificate of deposit (CD), stocks, a vehicle, or savings.
Personal loans can be used for a variety of purposes, including consolidating credit card debt, paying off higher-interest debt, large expenses (such as a major appliance or a vacation), or even establishing or improving your credit score. credit.
Home equity loans can also be used for a variety of purposes, such as debt consolidation, large one-time expenses, or educational or medical expenses. Keep in mind that a home equity loan is a one-time payment, so a home equity line of credit (HELOC) may be more appropriate for situations (such as a lengthy home renovation project or starting a business venture) where a large amount of ongoing financing is required, or money will be needed continuously over a period of time.
When considering which loan to access for financing in the specific case of home renovations or improvements, a home equity loan may be a better option than a personal loan. This is because, in most cases, the interest paid on personal loans is not tax deductible; however, interest payments on home equity are: provided that the home equity loan is used to “purchase, construct, or substantially improve the home of the taxpayer securing the loan.”
Loan Application and Approval
Application and approval of personal loans
When applying for a personal loan, the lender will generally consider the following:
- Your credit score and credit report
- Your income and employment status
- Any debt you may have (specifically, your debt-to-income (DTI) ratio)
- The interest rate allowed by applicable state law
- Collateral (if applying for a secured loan)
The amount of the loan and the length of the payment term are also important factors that will determine the interest rate of the loan. Personal loan amounts can range from a few hundred dollars to as much as $100,000.
Please note that personal loans may also include fees such as:
- origination fee
- Fees for processing documents and procedures
- Credit insurance (optional)
- Disability insurance (optional)
- No show insurance (for secured loans)
- Late Payment Penalty Fees
Typically, it will take between one and seven business days to get a personal loan, depending on the lender.
Home Equity Loan Application and Approval
When you apply for a home equity loan, a lender will calculate the loan-to-value (LTV) or combined loan-to-value (CLTV) ratio to consider how much money they will let you borrow. This calculation essentially answers the question: If the house is sold, would it cover the amount owed on your original mortgage and this additional loan, and by how much? It is also an important factor in determining the interest rate on your loan. Generally, the lower your LTV, the lower your interest rate.
To determine the value of your home, there is usually an appraisal process, similar to getting a conventional mortgage. This may involve various fees and closing costs. Your income and credit history will also be considered. The maximum amount you can borrow is usually equal to around 80% percent of your home’s equity. Keep in mind that most lenders have a minimum amount that they will lend in this type of loan agreement, usually around $10,000.
Interest rates and payment terms
The interest rate on a personal loan can be fixed or variable, and can be lower than a credit card, but generally higher than a home equity loan (especially in the case of unsecured personal loans) . In general, evaluate the interest rate on a personal loan against the national average: if it’s lower, that’s a good sign. On a personal loan, the interest rate can range from 6-36%, depending on your credit history.
Personal loan terms can range in length from around 1 to 5 years, occasionally longer. It is advisable to choose the shortest loan term that you can pay monthly.
Interest rates on home equity loans are generally fixed and tend to be lower than personal loans and credit cards because the home is used as collateral. However, the risk here is that if the loan is not paid, the lender may repossess and sell the house to cover the remaining debt. It also means that if the value of your home goes down, the amount you end up owing may exceed the value of the home.
Interest rates for home equity loans can range from as low as 1.89% to around 11.75%, depending on the duration and credit and home equity history of the borrower, with an average of around 4 to 5 %.
Home equity loans can range in length from 5 to 30 years.
Other considerations
When considering any loan, it’s important to shop around and compare the terms and offers offered by different banks, credit unions, and finance companies. Under the Truth in Lending Act (TILA), lenders must disclose the following information before signing any loan agreement so consumers can understand and compare different offers:
- The total amount you are borrowing
- Refund amounts and their due dates
- How much it costs to borrow the money (called a “finance charge”; includes interest and any fees applicable to the loan)
- The Annual Percentage Rate (APR)
- Any penalties that may apply for late payments
- The consequence(s) of not paying the loan and the actions the lender can take
- Any penalties that may apply for repaying the loan early
Try using a loan calculator to get an idea of how much you’ll end up paying.
Does a home equity loan have lower interest rates than a personal loan?
Usually yes. On a personal loan, the interest rate can range from 6-36%, depending on your credit history. For home equity loans, the interest rate can be as low as 1.89%, ranging up to around 11.75% (depending on the length of the loan), with the average ranging from 4 and 5%.
Does a personal loan have lower interest rates than a credit card?
Personal loans can have lower interest rates than a credit card, but they don’t have to. It will largely depend on the length and type of loan (secured or unsecured, for example), as well as the borrower’s credit history.
What is the difference between a personal loan and a home equity loan?
The biggest difference between a personal loan and a home equity loan is the structure: a home equity loan is a specific type of secured loan in which the borrower’s home is used as collateral. While both offer one-time lump-sum payments, the amounts of each can vary and the approval process is different (usually significantly shorter, in the case of personal loans).
The bottom line
When considering whether to pursue a personal loan or a home equity loan, it’s important to determine if either option is best for your financial situation (or if another type of credit, such as a line of credit or refinancing option, might be right for you). more appropriate). appropriate). Use a loan calculator to get an idea of how much you’ll potentially spend. Considering the purpose of the loan and the amount you’ll need, shop around for the best options among several lenders, and make sure you understand the full agreement and associated fees before you sign anything.
