Home Equity Loan Vs. Personal Loan: Which Is The Best Option?

If you suddenly need funds for a major purchase, consolidating debt or covering an emergency expense, there are several loan options you can consider. For right now, though, we’ll focus on just two: Homeowners with enough equity in their house can apply for a home equity loan, or – home equity or no home equity – you can go the route of an unsecured personal loan and not risk any collateral. Both of these loan options have benefits and drawbacks, so the one that works better for you will depend on your financial situation and financial goals.

Let’s take a close look at a home equity loan versus a personal loan and the factors you should consider before applying for either.

Personal Loan Vs. Home Equity Loan: How They Differ

Both personal loans and home equity loans are installment loans that allow you to use funds for almost any reason, including:

• Home improvement projects
• Debt consolidation
• Emergency costs
• Medical expenses
• Large expenses or purchases

See the chart below for an at-a-glance perspective of personal loans versus home equity loans.

How Personal Loans Work

Personal loans are typically unsecured loans, meaning you don’t need to back up your loan with collateral such as your car or your home. If you stop making payments, lenders can’t take your personal belongings since you didn’t use them as collateral. Lenders can, however, send your unpaid loan to collections, and your credit score can take a big hit.

Once your personal loan application is approved, you’ll receive a lump-sum payment that you typically pay back in fixed monthly installments. Your interest and annual percentage rate (APR) will largely depend on your credit history, additional debts (student loans, car loans, etc.) and ability to pay back your loan. So, the higher your credit score and the lower your DTI, the better the rate and term you’ll likely receive. You’ll need good or excellent credit to get a lower interest rate.

How Home Equity Loans Work

Home equity loans are a type of second mortgage, which uses your home as collateral. That means if you can’t pay back your loan, the lender can seize your home through the foreclosure process.

The amount of money you can qualify for is determined by factors such as home equity (the value of your home minus your remaining mortgage balance), your credit history and your income. Most lenders will allow you to borrow up to 80% (and some will even allow for 85%) of your home’s loan-to-value ratio (LTV), which measures your loan amount against your home’s value.

Since a home equity loan is secured by the collateral that is your home itself, borrowers tend to get a lower interest rate than they would with an unsecured loan. A repayment term can also be much longer with a home equity loan. Just like with a personal loan, you’ll receive your loan amount in a lump sum and pay it back over a set term, usually with a fixed rate.

While both personal loans and home equity loans can come with origination fees, only home equity loans come with closing costs. This extra expense can include appraisal fees, the cost of running your credit, title insurance premiums and other costs.

Pros And Cons Of Home Equity And Personal Loans

Both personal and home equity loans carry certain risks and benefits. Review the following upsides and downsides of each option before choosing which loan you want to pursue, if either.

Home Equity Loans

Some risks you’ll face specifically when using a home equity loan for debt consolidation include building up more debt and seeing a decrease in home value that leaves you with negative equity.

Personal Loans

When To Choose A Home Equity Loan Or Personal Loan

Whether a home equity loan or a personal loan is better for you will depend mainly on your personal finances.

To determine the type of loan you need, consider whether your situation fits the scenarios described below.

When To Choose A Personal Loan

Below are some reasons you might apply for a personal loan:

• You want money quickly. The time it takes to get a personal loan is usually faster than the approval process for a home equity loan. You can potentially get cash in your account within 1 business day, but the exact amount of time it takes will depend on the loan amount and the lender. A home equity loan is more involved than a personal loan, usually resulting in a longer wait for cash.
• You don’t want to borrow a lot of money. Generally, a personal loan is best if you want to borrow $50,000 or less. In rare instances, borrowers can borrow up to $100,000.
• You want an unsecured loan. Since most personal loans are unsecured, loan approval will likely be contingent upon your credit score, income and other financial circumstances. Your credit score will probably suffer if you default on payments, but you won’t risk losing your home.

When To Choose A Home Equity Loan

Here are some reasons you might consider a home equity loan:

• You want a lower interest rate. Home equity loans tend to have a lower interest rate than personal loans. If you believe you can make on-time payments and are comfortable with the risk of losing your home, this loan option could be a good one for you.
• You want long-term flexibility. A personal loan may offer a variety of repayment term options, but the repayment term for a home equity loan is typically longer and can be up to 30 years. If your repayment term is longer, your monthly payments may be lower with a home equity loan than a personal loan, but it depends on the size of the loan and how much you’re paying back.
• You want to borrow more money. Rocket Loans℠ offers personal loans ranging from $2,000 – $45,000. If you want to borrow a larger sum of money, it may be a better idea to go with a home equity loan, especially if you have significant home equity.

How To Get A Personal Loan Or Home Equity Loan

The application process for personal loans and home equity loans have some similarities, but each comes with its own set of requirements.

Applying For A Home Equity Loan

To get a home equity loan, you’ll typically follow these steps:

1. Check your credit score and DTI. Before you begin the loan process, check your credit report to make sure you meet at least the minimum credit requirements for a home equity loan. It could also help to calculate your DTI ahead of time.

2. Research multiple lenders. While you could borrow through your current mortgage lender, you may want to consider other financial institutions such as traditional banks, credit unions and online lending platforms. Each can offer unique promotions and benefits.

3. Get a home appraisal. Once you choose a lender, they’ll have your home appraised to determine how much you can potentially borrow. Getting an appraisal means paying an appraisal fee.

4. Collect your documentation. When you apply for a home equity loan, be prepared to show plenty of paperwork. Your lender might ask for copies of your most recent bank account statements, pay stubs, tax returns and W-2 forms. They might also ask for your most recent credit card statements.

5. Submit an application. Once you have all your documents, you can fill out and submit an application. From there, your lender will review your personal finances and check your FICO^® Score before approving you for a home equity loan.

Applying For A Personal Loan

Applying for a personal loan is usually an easier and faster process than applying for a home equity loan. As with a home equity loan, you should begin by checking your credit and comparing rates and terms from different lenders. You may also consider using a loan calculator to find the best personal loan product for your situation.

To get an idea of your potential interest rate, it’s best to get prequalified for a loan. Prequalification requires a soft credit check, which won’t affect your credit score. Once you’re ready to fill out a full application, gather the necessary documents and submit your completed form to the lender.

After you’ve submitted your application, your lender will usually be able to tell you in just a few hours if you’re approved for a loan, and you’ll likely receive your loan funds in 1 – 7 business days.

In certain cases, Rocket Loans can offer same-day financing for personal loans, so the money might hit your account the same day you’re approved.¹

Home Equity And Personal Loan Alternatives

Here are some other loan options if neither a home equity loan nor a personal loan is the right fit for you.

HELOC

A home equity line of credit, or HELOC, works similar to a home equity loan in that you borrow against your equity and use your home as collateral. Instead of a lump sum, though, you borrow from a line of credit that you’ll pay back as you go. A HELOC includes many of the same risks as a home equity loan, including possible foreclosure.

Cash-Out Refinance

If you want a higher loan amount with a faster approval process, perhaps consider a cash-out refinance. This method allows you to refinance your mortgage for a lower interest rate (in all likelihood) while converting your equity into cash you can use as desired. A cash-out refinance can be a good way to get a loan if you’re a homeowner with some accrued equity.

0% Introductory APR Credit Card

Some credit card issuers offer a 0% APR promotional period when you sign up for a new card, giving you potentially up to 18 months of interest-free spending money. Once that period ends, though, you’ll be hit with a high interest rate for your remaining balance. Many borrowers use this type of credit card to make a balance transfer to consolidate their credit card debt.

Final Thoughts

If deciding between a personal loan and a home equity loan, the best choice will always depend on your unique financial circumstances. Think carefully about whether you’re willing to put your home up as collateral in exchange for a lower interest rate, or whether you’d rather receive money faster but have a shorter loan repayment term. Also consider how much you need to borrow and whether you can afford the payments.

Think a personal loan sounds like the right option? Apply today with Rocket Loans.

¹Same day funding is available for clients completing the loan process and signing the Promissory Note by 1:00 p.m. ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same day funding, but results may vary, and your bank may have rules that limit our ability to credit your account. We are not responsible for delays that may occur due to an incorrect routing number, an incorrect account number or errors of your financial institution.