Personal Loans vs. Home Loans – Forbes Advisor
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When it comes to versatile, affordable, and widely available loan products, a personal loan or home equity loan is hard to beat. But how do you know which one to choose?
That answer depends on a number of variables, many of which have to do with your specific financial circumstances. We’ll show you the pros and cons of both types of loan so you can get a better idea of which is right for you.
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What is a personal loan?
Personal loans are unsecured loans that do not require collateral – something of value that secures the loan and that the lender can repossess if you fail to make the repayment. Mortgages, home equity loans, and auto loans, where the loan is tied directly to an asset, are examples of secured loans.
You can use personal loans for a variety of different expenses, including:
- Debt consolidation
- Wedding expenses
- Home improvement
- Medical expenses
- Financing a major purchase such as a boat or car
The repayment periods for personal loans are between one and seven years, depending on the lender. In general, the longer the term, the higher the interest. Most personal loans have fixed interest rates between 4% and 36%. In addition, the limits are typically between $ 500 and $ 50,000, but some providers lend out as much as $ 100,000.
Both your interest rate and the amount you can borrow will depend on your creditworthiness, income, and any other outstanding debt.
How personal loans work
Once you’ve applied for a personal loan, it usually takes anywhere from a few minutes to a week to get a decision, depending on the lender. Lenders typically require a credit score of at least 660, and they may also have an annual income limit that the borrower must meet.
If approved, the lender will usually send your money to your bank account in a lump sum within a few days. The repayment begins immediately after the loan is paid out and you pay interest on the entire loan amount, regardless of whether you use it in whole or in part.
Some lenders also charge personal loan issuance and prepayment fees, but this varies from lender to lender.
Related: 5 Personal Loan Requirements You Should Know Before Applying
When to choose a personal loan
A personal loan works best when you only need to borrow a few thousand dollars and want a hassle-free loan application process. You can also qualify for a low interest rate if you have great credit. In addition, if you don’t have equity in your home, you won’t qualify for a home loan, so a personal loan is the right choice.
Related: Best Personal Loans 2021
What is a Home Equity Loan?
A home loan is a secured loan that uses the equity built up in your home – the current market value of your home minus the remaining mortgage balance – as collateral. Most lenders require that you have a home equity of at least 15 to 20% and a credit rating of at least 620. You can borrow up to 85% of your equity and repay it over a period of five to 30 years.
This is how home equity loans work
If you have at least 15 to 20% equity in your home, you can qualify for a home loan. Homeowners can contact their mortgage lender or other credit intermediary and apply for a home loan. When you take out, you usually have to pay fees and closing costs between 2% and 5% of the total loan amount. Some lenders can waive these additional costs.
The home equity loan is secured by your home and is therefore subordinate to the mortgage. The loan will then be paid out as a lump sum and you will have to pay interest on the entire loan balance. Since your home is securing the loan, the lender can foreclose if you don’t pay on time.
When should one opt for a home loan?
If you don’t qualify for a low interest rate on a personal loan and you have enough equity in your home, consider a home loan. Because home equity loans use your home as collateral, the interest rates are lower than personal loans.
If you use the proceeds on a home repair or renovation project, you can deduct the interest on the home loan from your taxes, which is not possible with a personal loan.
Related: The Best Lenders For Home Loans
Advantages and disadvantages of personal loans
Benefits of personal loans
- Approval takes less time compared to a home loan.
- There is no risk that the bank will repossess property in the event of a default.
Disadvantages of personal loans
- Interest rates can be high, depending on the size of your loan and your creditworthiness.
- Some lenders charge early repayment penalties if you repay the loan early.
- The repayment deadlines are shorter than home loan, which means that the monthly payments can be higher.
Advantages and Disadvantages of Home Loans
Benefits of Home Loans
Disadvantages of home loan
- Borrowers who default can repossess their home.
- It can take a few weeks for the money to be received, much like closing a house.
- Some lenders have high minimum loan amounts that may be more than you need.
- The closing costs are often high.
Alternatives to personal loans and home equity loans
If you need cash, there are other options besides a personal loan or a home equity loan.
Borrowers who don’t need a lot of cash should consider a credit card, especially if they qualify for an interest-free finance card. These offers usually last six months or up to 21 months. Any unpaid balance at the end of the promotional period will be charged interest up to full repayment. Even if you cannot repay the full amount within that time, you may pay less interest than a personal or home equity loan.
Credit cards also offer more flexibility, as the minimum payment is almost always much lower than a personal or home equity loan. For example, if you lose your job or have an emergency, it is easier to afford a minimal credit card payment than a personal loan or home loan payment.
If you need cash, you can withdraw a cash advance with your credit card. However, the card provider usually charges a cash advance fee, usually between 3% and 5% of the transaction amount, in addition to an annual percentage rate (APR). The cash advance earns interest immediately. The interest rates on cash advances are higher than a regular credit card transaction, often up to about 30% APR.
Home Equity Line of Credit
Like a home equity loan, a home equity line of credit (HELOC) uses your home’s equity as collateral; Instead of a lump sum, however, a HELOC gives you a limit that you can use as needed.
HELOCs consist of two parts: the withdrawal period and the repayment period. The draw period refers to access to the money. During the draw period, a borrower is only responsible for paying interest on the money they borrowed. After the drawing period has expired, usually after 10 years, the repayment period begins. The repayment period is usually 20 years and the borrower has to make monthly payments on the principal amount borrowed and the interest.
As with home equity, HELOCs incur acquisition, appraisal, and submission fees, and you need between 15% and 20% equity in your home to qualify.
401 (k) loan
If you have a current 401 (k), you can borrow from the balance and use the money to pay off debts, go on vacation, or do a home repair. The maximum amount you can borrow is $ 50,000 or 50% of your balance, whichever is lower.
Unlike other types of credit, a 401 (k) loan has no minimum credit rating or income requirement. The interest on a 401 (k) loan is deposited into your account just as you pay interest to yourself.
Only investors who are confident of their job security should take out a 401 (k) loan. If you are laid off or laid off, you must return the money on or before the next tax day. If you cannot afford this, the remaining balance will be considered a payout. Borrowers younger than 59.5 years owe a 10% penalty and income tax.
If you have at least 20% equity in your home, you can refinance and withdraw excess equity in your home. You can use this money for a variety of reasons, such as: B. to pay off other loans, to remodel your existing home or to buy another property.
With a cash-out refinancing, you receive a new mortgage with a different term and interest rate. The total balance will also be higher than the previous balance and you may receive a higher monthly payment if the interest is now higher than when the loan was first taken out.