Taking out a loan is one way to cover unexpected or large expenses, such as home renovations, school fees, or a down payment on an investment property.
However, there are different types of loans that help you reach these goals, such as home equity loans and personal loans. Both of these options can provide cash in bulk, but the two are not compatible. One is suitable for smaller loans, easier to qualify, and potentially more expensive. The other offers larger amounts, lower interest rates and longer loan terms.
home equity and personal loanss
Home equity loans and personal loans are two ways to borrow cash. With a home equity loan, you borrow the equity (the portion you actually own) of your home in exchange for a lump sum. These loans are usually issued by banks, credit unions and mortgage lenders.
Personal loans, on the other hand, do not require collateral (that is, assets that the lender accepts as collateral to fund the loan) and are available through most financial institutions and lenders.
Barry Rafferty, senior vice president of Capital Markets at Achieve, said: “Instead of home equity, lenders make decisions based on income, credit history and debt-to-income ratio.”
In both cases, the borrower receives a lump sum payment upfront, plus a fixed interest rate and consistent monthly payments for the life of the loan.
Despite their similarities, home equity loans and personal loans are not the same thing. See below for the main differences between these two types of loans.
What is a Home Equity Loan?
Nicole Rueth, senior vice president of the Rueth team at OneTrust Home Loans, said:
A home equity loan is technically a kind of second mortgage. If you default on your payments, the main mortgage lender will have the claim on the home first, followed by your home equity lender. Additionally, a home equity loan adds a second monthly payment to your household budget on top of your home loan’s main payment.
How Home Equity Loans Work
With a home equity loan, a lump sum is paid after closing. Its balance and interest are spread over the loan term ranging from 5 to 30 years. The interest rates on these loans are fixed, so payments remain constant throughout the term.
How To Get A Home Equity Loan, must be a homeowner and have paid off a significant portion of the mortgage. Most mortgage lenders require that you own at least 10% to 20% equity in your home. To calculate equity, take the fair market value of your home (you can check this with your local valuation district) and subtract your current mortgage balance. Then divide that number by the value of the house. For example, if your house is worth $500,000 and your mortgage balance is $400,000, your home equity is $100,000, or 20%.
In addition to having equity in your home, you must also meet the following requirements.
- 680+ credit score
- Debt to Income Ratio (DTI) of 45% or less
- Loan-to-value (LTV) ratio of 90% or less
Some lenders may approve borrowers outside these requirements, so if you’re not sure you’re eligible, do your research before applying.
Pros and Cons of Home Equity Loans
Home equity loans have some notable advantages when compared to personal loans, but not all. Here are some pros and cons you might want to consider before removing it.
Pros: low interest rates
Choosing a home equity loan over a personal loan usually results in a lower interest rate because home equity loans require collateral and reduce the risk borne by the lender. “Personal loans are not secured by anything, so interest rates are higher,” he says Rueth.
Low interest rates can mean big savings over the life of the loan. For example, if he borrows $30,000 for a 5-year Home Equity loan at an interest rate of 7%, by the end of the period he will have paid $5,642 in interest. Comparing this to a personal loan with 12% interest on the same terms, the interest rate is over $10,000 for him.
Cons: Long application process
One of the main drawbacks is the slow processing of home equity loans. That’s because lenders need to value your property in addition to your financial profile. They also require an evaluation and can add a week or more to your timeline depending on where you are. ,” says Rafferty. “The application process is more complicated.”
Exact timelines vary by lender, but for personal loans, processing and funding can take as little as 24 hours. A home equity loan, on the other hand, can take a month or more in some cases.
Pros: Long loan term
A home equity loan can be beneficial if you want to spread your expenses over a longer period of time. Home equity loans often span 30 years, while personal loans have the longest he’s 6 years.
These longer loan terms result in lower monthly payments and help keep your household cash flow healthy.
Cons: They endanger your home
A home equity loan uses your home as collateral. This reduces the lender’s risk and allows them to offer lower interest rates, but shifts much of the risk to you, the borrower. If you don’t make payments as agreed, the lender can foreclose on your home.
Another risk to consider: Taking out a home equity loan can mean you have a significant balance on your home. If home values drop in your area, you may end up with more debt than the home is worth. This can make it difficult to sell your home or pay off your mortgage.
Pros: Borrow more
Home equity loans generally offer larger loans than personal loans. Some lenders offer home equity loans up to $500,000.
Personal loan limits are usually much lower than this. It depends on the lender, but most personal loans have a $100,000 limit for him.
Cons: Only Homeowners Are Eligible
Personal loans consider credit scores, income, and financial details when determining eligibility. In a home equity loan, the value of the home and the existing mortgage balance play an important role in addition to all these factors. If you haven’t paid off your existing mortgage well, or if you don’t own a home at all, you’re not eligible.
What is a personal loan?
A personal loan is a type of unsecured loan that does not require collateral. Instead, eligibility is based on financial details such as income, credit score, debt history, and debt-to-income ratio.
Similar to home equity loans, personal loans offer a lump sum payment up front and pay back the funds over a period of time with monthly payments. Most have fixed interest rates and last from 1 to 6 years.
How personal loans work
Many consumers use personal loans to pay for large expenses such as medical bills, wedding expenses, home repairs, and even debt consolidation. To begin the process, complete the application form for your chosen lender and agree to a credit check. Generally speaking, you need a credit score between 610 and 660 to qualify, but this varies by lender.
Scores also affect the cost of loans. As Rafferty explains, “Personal loan interest rates vary greatly depending on your credit score.”
Borrowers with a lower credit score usually get higher interest rates, while borrowers with a higher credit score get lower interest rates. If you’re worried about how your current score might affect your interest rates, talk to the bank or credit union where you have your checking and savings accounts. Some institutions offer loyalty benefits to save you money.
Once your personal loan is approved, you can receive a lump sum payment from your lender. Then start making monthly payments until the entire balance plus interest is paid off.
Advantages and disadvantages of personal loans
While there are some advantages to using a personal loan over a mortgage, there are also drawbacks. Consider these loans from both angles before proceeding with either one.
Pros: they are faster
Personal loans have fewer hurdles to jump. There is no home appraisal, and the lender only evaluates your credit report and income, not the home or your equity. You can usually complete the process and receive your loan proceeds in just a few days.
“For personal loans, many lenders allow prospective borrowers to complete their applications online,” says Rafferty. “In some cases, we are approved and funded in as little as three days.”
Cons: They come with higher interest rates
The biggest downside is that interest rates on personal loans are higher than home equity loans. This is riskier for the lender as personal loans are not secured by collateral of any kind.
With a home equity loan, if you default on your payments, the lender will foreclose on your property to recoup your losses. Personal loans can’t do that, so lenders charge higher interest rates to account for the added risk.
Pros: You can borrow even a small amount
If you need to borrow just a little bit, a personal loan can help. “Many lenders set the minimum loan amount for home he equity his loans at $10,000 or more. For personal loans he may be as low as $1,000,” Rafferty said. say.
You can also reduce your long-term interest burden by borrowing only what you need.
Cons: Small loan amount, short term
However, if you need a large sum, a personal loan may not work for you. Personal loan limits aren’t usually as high as his home equity loan limit, and with some lenders he can go up to $500,000.
In addition, personal loans have a shorter term. This means you have to pay the money back sooner, which can result in higher monthly payments and strain your budget.
2 ways to choose
Choosing between a home equity loan and a personal loan depends on your goals and timeline. Generally speaking, Rueth says he “always” recommends taking out a home equity loan over a personal loan, with a few exceptions.
“If a consumer doesn’t own a home, wants a quicker process, or needs extra money on top of a home equity loan, they should opt for a personal loan,” she said. increase.