Home equity vs. personal loans
What is the difference between a home equity loan and a personal loan?
A home equity loan and a personal loan both offer one-time lump sum payments that must be repaid in installments over an agreed period of time. The main difference, however, is that home equity loans are a special form of secured loan that uses the borrower’s home as collateral. Personal loans, on the other hand, can be secured or unsecured by collateral and are a much broader and more diverse category.
Because personal loans tend to have less stringent approval processes than home equity loans, they can generally be obtained more quickly and easily. While home equity loans typically take longer to be approved, they typically offer a lower interest rate than a personal loan and may also offer a larger loan amount. However, before deciding on either option, it is important to consider the amount needed and the purpose of your loan.
The central theses
- Home equity loans and personal loans both offer one-time lump sum payments that are repaid in installments over a period of time.
- A home equity loan is a type of secured loan that uses the borrower’s home as collateral, while personal loans can be secured or unsecured by collateral.
- Personal loans tend to be quicker and easier to approve, while home equity loans require a property appraisal and a lengthier 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 borrower’s home equity.
- Interest payments on personal loans are not tax-deductible, while interest payments on home ownership are possible if the loan is used to “purchase, build, or substantially improve the taxpayer’s home that secures the loan.”
Loan Structure and Purpose
A home equity loan involves borrowing money using the value of your home (your home equity, more specifically) as collateral. The FTC defines home ownership as “the difference between what you owe on your mortgage and how much money you could get for your home if you sold it.” For this reason, a home equity loan is sometimes called a “second mortgage.”
Many personal loans are unsecured, but there are secured personal loans that can be backed by collateral such as a certificate of deposit (CD), stock, a vehicle, or savings.
Personal loans can be used for a variety of purposes, including consolidating credit card debt, paying off higher-interest debt, making a large expense (like a large appliance or a vacation), or even establishing or improving your credit score.
Home equity loans can also be used for a number of purposes such as: B. Debt consolidation, large one-off expenses, or education or medical expenses. Keep in mind that a home equity loan is a lump sum payment, so a home equity line of credit (HELOC) may be a better fit for situations (e.g., need ongoing financing or need cash continuously over an extended period of time becomes.
When considering which loan to use to finance a specific home renovation or improvement, a home equity loan may be a better option than a personal loan. Because in most cases, the interest on personal loans is not tax deductible; However, interest payments on a home are – on condition that the home loan is used to “purchase, build, or substantially improve the taxpayer’s home that secures the loan”.
Loan Application and Approval
Application and approval of a personal loan
When applying for a personal loan, the lender usually considers the following:
- Your credit score and credit report
- Your income and employment status
- Any debt you may have (especially your Debt to Income Ratio (DTI))
- The interest rate permitted under applicable national law
- Collateral (when applying for a secured loan)
The loan amount and the length of the repayment period are also important factors that determine the interest rate on the loan. Personal loan amounts can range from a few hundred dollars to $100,000.
Keep in mind that personal loans can also include fees such as:
- incorporation fee
- Fees for handling documents and paperwork
- Credit insurance (optional)
- Disability insurance (optional)
- Non-Filing Insurance (for secured loans)
- Late Delay Charges
Depending on the lender, it usually takes between one and seven business days to receive a personal loan.
Applying for and Approving a Home Loan
When you apply for a home equity loan, a lender calculates your loan-to-value ratio (LTV) or combined loan-to-value ratio (CLTV) to see how much money you can borrow. This calculation essentially answers the question: If the house is sold, would it cover the amount of your original mortgage plus this additional loan, and by what amount? It is also an important factor in determining the interest rate on your loan. Typically, the lower your LTV, the lower your interest rate.
In order to determine the value of your home, an appraisal is usually carried out, similar to a conventional mortgage. This can entail various fees and closing costs. Your income and credit rating are also taken into account. The maximum amount you can borrow is typically around 80% of your home equity. Keep in mind that most lenders have a minimum amount they will lend in this type of loan agreement, typically 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 that of a credit card but usually higher than that of a home equity loan (especially unsecured personal loans). In general, evaluate a personal loan interest rate by comparing it to the national average: if it’s lower, that’s a good sign. With a personal loan, the interest rate can be between 6 and 36%, depending on the credit rating.
Personal loan terms can range from 1 to 5 years, sometimes longer. It is advisable to choose the shortest loan term that you can afford to pay monthly installments on.
Interest rates on home equity loans are usually fixed and tend to be lower than both personal loans and credit cards because the home is used as collateral. However, there is a risk here that if the loan is not repaid, the lender may take back the home and sell it to cover the outstanding balance. It also means that if the value of your home goes down, the amount you end up owing may exceed the home’s value.
Interest rates on home equity loans can range from 1.89% to about 11.75%, depending on the term and the borrower’s home ownership and lending history, with the average being about 4% to 5%.
Home equity loans can have terms ranging from 5 to 30 years.
When considering a loan, it’s important to shop around and compare the terms and deals offered by different banks, credit unions, and financial firms. The Truth in Lending Act (TILA) requires lenders to disclose the following information before signing a loan agreement so consumers can understand and compare different offers:
- The full amount you borrow
- Repayment amounts and their due dates
- How much it costs to borrow the money (referred to as the “financing fee”; includes interest and any fees incurred on the loan)
- The Annual Percentage Rate (APR)
- Any penalties that may apply to late payments
- The consequence(s) of non-repayment of the loan and actions the lender can take
- Any penalties that may apply for the early repayment of the loan
Try using a loan calculator to get an idea of how much you will end up paying.
Does a home equity loan have lower interest rates than a personal loan?
Normally yes. With a personal loan, the interest rate can be between 6 and 36%, depending on the credit rating. For home equity loans, the interest rate can be as low as 1.89% and go as high as around 11.75% (depending on the length of the loan), with the average being around 4-5%.
Does a personal loan have lower interest rates than a credit card?
Personal loans may or may not have lower interest rates than a credit card. This largely depends on the length and type of loan (e.g. secured or unsecured) as well as the borrower’s creditworthiness.
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 special type of secured loan that uses the borrower’s home as collateral. While both offer lump sum one-time payments, the amounts may differ and the approval process is different (usually significantly shorter for personal loans).
The final result
When considering whether to take out a personal loan or a home equity loan, it’s important to determine whether one of the two options is best for your financial situation (or whether another type of loan, such as a line of credit or a refinancing option, is more suitable). suitable). Use a loan calculator to get an idea of how much you might end up spending. Considering the purpose of the loan and the amount you need, research the best options between different lenders and make sure you understand the entire agreement and any associated fees before signing anything.