Home Equity Loan vs Personal Loan

If you own a home, you have some options when it comes to borrowing money.

Two of those options, personal loans and home equity loans, offer flexibility that allow you to use them to pay for a variety of things. But there are some big differences to consider too, from the eligibility requirements to interest rates to the application processes. If you’re trying to decide between the two, here are some things to keep in mind. 

What is a home equity loan?

Sometimes called a second mortgage, a home equity loan can provide access to a relatively large amount of money by allowing you to borrow against the value of your home. People can take out home equity loans to pay for a variety of things, such as home renovations, college tuition or medical treatment. Home equity loans are secured by your house; that means if you can’t pay back the loan, the lender could foreclose on your home.

To qualify for a home equity loan, you’ll need to meet the lender’s criteria. First, it matters how much you owe on your mortgage, if you have one. When a lender is looking at giving you a home equity loan, they consider the amount of your mortgage versus the appraised value of your home (this is the loan-to-value ratio). A high loan-to-value ratio is considered risky by the lender because the sale of your home is less likely to pay off the loan should you default.

The amount you can borrow is generally limited to 85% of the equity you have in your home although other factors come into play as well such as your income, credit history and market value of the home. So, if you’re the owner of a brand new home and just took out a large mortgage, you may not qualify for a home equity loan.

Pros and cons of home equity loans

Pros:

Interest rates are typically lower than credit cards or personal loans.

Depending on how much equity you have in your home and the value of your home, it may be possible to borrow fairly large amounts of money.

Cons:

There’s significant paperwork involved and the process usually takes longer with a home equity loan than for a personal loan. A home equity loan may also require a home appraisal.

Since it’s secured by your home, failure to pay back the loan means that the lender can foreclose on your home.

Closing and origination fees can add to your overall costs.

What is a personal loan?

A personal loan is money that an individual borrows from a bank, credit union or online lender, usually paid back with interest in fixed, monthly payments over a set term. If the personal loan is unsecured, it means that you do not use any of your possessions as collateral to secure the loan. Unsecured personal loans may require a higher credit score than secured loans to be approved.

Lenders look at your creditworthiness and ability to pay when determining if you qualify for a personal loan. All other things being equal, borrowers with high credit scores usually get  lower interest rates, while those with low credit scores usually get higher interest rates.

Unlike certain loans, like auto loans, which can only be used for one purpose, personal loans are more versatile. You typically get the payment in a lump sum. A common use is to consolidate high-interest rate credit card debt. By consolidating existing debt into one, lower fixed payment each month, you can streamline how you pay down debt. Personal loans could also be used for home renovations, vacations, weddings and other special events. Personal loans generally have fixed rates; which are usually lower than the rates on credit cards. 

Pros and cons of personal loans

Personal loans have some attractive features, but there are also some considerations to keep in mind.

Pros:

You can generally get a decision earlier than you would with a home equity loan.

Personal loans can be used for different things such as debt consolidation, home renovation, wedding or vacation.

Rates on personal loans are generally lower than those on credit cards.

Cons:

If you have a low credit score, you could end up paying a high interest rate.

Home equity loan vs personal loan - how to choose

While home equity loans and personal loans are similar in that they can be used to pay for a variety of uses, there are also differences. Understanding the pros and cons can help you make a decision that’s best for you.

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This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.