Home Equity Loan vs Personal Loan 2022
If you want to borrow money to consolidate pay for a home renovation project, you have personal loans and home equity loans in two types loans. Here, we compare home equity loans and personal loans to help you decide which one might be right for you.
A personal loan is a lump sum of money borrowed from a financial institution that can be used for almost any purpose. Learn more about personal loans and how they work.
Home equity is the portion of your property that you truly “own.” Your lender has an interest in the property until you pay off your mortgage, although you’re still considered to be the homeowner.
Home equity is often an owner’s greatest asset. It can be used later in life, so it pays to know how it works and how to use it wisely.
Home equity starts with your home’s current value. Now subtract the amounts owed on any mortgages or other liens against it.These liens might be purchase loans that you used to buy the house, or second mortgages that were taken out later. The difference is your home equity.
Your lender doesn’t own any portion of the property unless you’ve obtained a shared equity mortgage, which isn’t common. You own the house, but it’s being used as collateral for your loan. Your lender secures its interest by getting a lien against it.
2-1)How Home Equity Works:
Assume you purchase a house for $200,000. You make a 20% down payment, and you obtain a mortgage loan to cover the $160,000 balance. Your home equity interest is 20% of value: The property is worth $200,000, and you contributed $40,000, or 20% of the purchase price. You “own” only $40,000 worth of it, although you’re the owner.
Now assume that the housing market blooms and your home’s value doubles. You’d have a 60% equity stake if the home is now worth $400,000, and you still owe only $160,000. Your loan balance remains the same, but the home’s value has increased, so your home equity goes up, too.
2-2)How Do You Build Home Equity?
You can take a few steps as a homeowner to increase your equity in your home.
Pay Off the Loan’s:
Your equity increases as you pay down your loan balances. Most home loans are standard amortizing loans with equal monthly payments that go toward both your interest and principal.3 The amount that goes toward principal repayment increases over time, so you build equity at a faster rate each year. Use our loan amortization calculator to figure your payoff date.
You wouldn’t build equity in the same way if you had an interest-only loan or another type of non-amortizing loan. You may have to make extra payments to reduce the debt and increase your equity in this case.
Your home equity grows as the value of your home rises. You can actively work to increase your home’s value through improvement projects. House prices rise and you’ll build equity without any effort on your part when the real estate market is healthy and growing.
A popular method of building home equity faster is a concept often referred to as “accelerated mortgage payments.”
Most homeowners make mortgage payments on a monthly basis, or 12 payments each year. You’ll make 26 payments per year if you split your monthly payment into two equal amounts instead and send your payment every two weeks: 365 days per year divided by 14 days equals 26.
This is the same as making 13 monthly payments. Using this approach will shave off a good bit of interest over the life of the loan. It will allow you to pay off the mortgage in a much shorter time frame and build equity faster.
Making monthly payments over the life of the loan would result in $93,256 in interest paid over 30 years if you have a $100,000, 30-year conventional mortgage at 5% interest. The amount of interest paid would be reduced to $75,489 and the loan would be paid off in 25 years if you were to make 1/2 the payment every two weeks instead.
You would save about $17,767 in interest and you would own your home free and clear five years sooner.
2-3)How to Use Home Equity:
Equity is an asset, so it makes up a portion of your total net worth. You can take partial or lump sum withdrawals out of your equity if you need to, or you can save it up and pass all the wealth on to your heirs.
There are a few ways you can put your asset to work for you if you decide to use some of your home equity.
Sell Your Home
You can take your equity in the home from the sale proceeds if and when you decide to move. You won’t get to use all the money from your buyer if you still owe on a balance on any mortgages, but you’ll be able to use your equity to buy a new home or to bolster your savings.
Borrow Against the Equity
You can get cash and use it to fund just about anything with a home equity loan, also known as a second mortgage. This allows you to tap into your home equity while you’re still living there. But your goal as a homeowner should be to build equity, so it’s wise to put that borrowed money toward a long-term investment in your future rather than just spend it.
Paying your current expenses with a home equity loan is risky because you could lose your home if you fall behind on payments and can’t catch up.
Fund Your Retirement
You can spend down your equity in your golden years with a reverse mortgage. These loans provide income to retirees. You don’t have to make monthly payments. The loan is repaid when you leave the house. But these loans are complicated. They can create problems for homeowners and heirs.
You must be at least 62 years old to take out a reverse mortgage. The home must be your primary residence.
2-4)Types of Home Equity Loans:
Home equity loans are tempting because you they can give you access to a large pool of money, often at fairly low interest rates. They’re also pretty easy to qualify for because the loans are secured by the real estate. Look closely at how these loans work so you fully understand the possible benefits and risks before you borrow money against your home’s equity.
It’s a Lump-Sum Loan
You can get all the money at once and repay it in flat monthly installments. The timeline could be as short as five years, or it could be as long as 15 years or more.
You’ll pay interest on the full amount, but these types of loans may still be a good choice if you’re thinking about a large, one-time cash outlay. You might want to consolidate higher-interest debts such as credit cards or buy a vacation getaway. Your interest rate is often fixed with this type of loan, so there won’t be any surprise hikes later, but you’ll likely have to pay closing costs and fees to take out the loan.
Home Equity Lines of Credit (HELOCs) Provide Flexibility
A HELOC allows you to pull funds out as you need them. You pay interest only on what you borrow. Similar to a credit card, you can withdraw the amount you need during the “draw period” as long as your line of credit remains open.
You must make modest payments on your debt during the draw period, which ends after a certain number of years, such as 10 or 12. You then enter a repayment period during which you pay off all the debt. The repayment period could include a hefty balloon payment at the end.
HELOCs often feature a variable interest rate, too, so you could end up having to pay back much more than you budgeted for over the life of the loan.
2-5)Risks of Borrowing Against Home Equity
A risk of tapping into home equity is that your home secures the loan. Your lender can take your house in foreclosure if you’re not able to repay the loan for some reason, and sell it to repay your debt.
The home would be sold quickly, so it probably won’t fetch the highest or best price. You and your family will have to find another place to live, adding to your financial concerns.
It’s smart to avoid using your windfall to splurge on designer clothes, big-screen TVs, luxury cars, or anything that doesn’t add value to your home. A safer move is to sock away cash for those treats, or spread out the cost by using a credit card with a 0% intro APR offer.
2-6)How to Qualify for a Home Equity Loan:
Check your credit score before you start shopping around for lenders and loan terms. You’ll most likely need a credit score of at least 680 to obtain a home equity loan.
A higher score is better. You most likely won’t be able to qualify for either type of loan until you repair your credit score if you can’t meet the minimum requirement.
You must show that you’re able to repay the loan. This means providing your credit history and your household income, expenses, debts, and any other amounts you’re obliged to pay.7
Your property’s loan-to-value (LTV) ratio is another factor that lenders look at when qualifying you for a home equity loan or HELOC. It’s often best to keep at least 20% equity in your property, which translates to an LTV of at least 80%, but some lenders allow bigger loans.
- Home equity is an owner’s interest in a home.
- It has the potential to increase over time if property values rise, or as you pay down your mortgage loan balance.
- You can calculate your equity by starting with your home’s current value, then subtracting the amounts you owe on any mortgages or other liens.
- There are ways you can work toward building up equity in your home.
- You can borrow money against your home’s equity, but this can be risky because your home secures the loan.
3) Personal loan:
A personal loan is a lump sum of money borrowed from a financial institution that can be used for almost any purpose. Learn more about personal loans and how they work.
3-1)What Is a Personal Loan
A personal loan is a loan you qualify for based on your credit history and income. Personal loans are sometimes called signature loans or unsecured loans because there is typically no collateral required to secure a personal loan.
Collateral is an asset that can be seized and sold to repay the loan. Home loans are secured by the home being financed. In most cases, lenders approve personal loans by evaluating your creditworthiness.
Personal loans are relatively easy to apply for and qualify for when compared to home and auto loans. That makes them useful for everything from small home improvements to expensive purchases. You can use the money for almost anything, but it’s wise to borrow only as much as you need and only for things that improve your finances or make a significant impact on your life.
3-2)How Personal Loans Work
When you get a personal loan, you typically receive your money in a lump sum, and you repay with fixed monthly payments over time. However, the details can vary from lender to lender, and there are a few factors to take into account.
Your interest rate depends on your credit and can be lower than credit card rates. With excellent credit, you may be able to borrow in the single digits.
Personal loans typically have fixed interest rates. Your interest rate doesn’t change, so you make the same monthly payment for the life of your loan.
They can also have variable rates, but this option is less popular. With a rate that can change, you may end up paying more or less interest depending on whether interest rates are rising or falling.
You usually repay personal loans over one to five years, but other terms are available. Compared to credit cards, personal loans can reduce the amount you spend on interest and provide a definite payoff date. With many personal loans, there is no prepayment penalty, so you can pay off your loan early and save on interest.
Some lenders charge origination fees for personal loans, while others build all of the costs into the interest rate. When you pay origination fees, your lender takes an upfront charge based on the amount you borrow. Origination fees usually range from 1% to 8% of your loan amount and may depend on your credit score.
3-3)How To Get Approved for a Personal Loan:
Lenders evaluate loan applications based on creditworthiness. Here are the factors they usually consider.
Lenders often check your credit or obtain a credit score to find out how you’ve handled credit in the past. Your credit reports contain details about previous loans, any late payments, and public records that lenders might want to know about.
Lenders need to verify that you have enough income to repay your loan. They may ask for details about your employment and income. They may also look at your current debt to make sure that adding a loan payment won’t consume too much of your monthly income.
3-4)Types of Personal Loans:
If you decide to try a personal loan, you can borrow from several sources.
Standard Personal Loans:
Banks and credit unions have a long history of offering personal loans. You can often apply in person or online and receive funds in your checking account quickly.
Peer-to-peer (P2P) sites and other online lenders offer loans from investors and financial institutions. These services are the most likely to use alternative credit scoring models, and the application process is often easy.
Some lenders work directly with service providers. They might fund dental work, fertility treatment, or landscaping projects. Borrowing is convenient, but it’s wise to shop around and compare offers.
Spending a Personal Loan:
You can spend the money from a personal loan on almost anything you want.
If you owe money on credit cards with high interest rates, you can pay off those debts with a personal loan that has a lower rate. You can eliminate debt more quickly because less of each monthly payment goes toward interest costs.
Small Home Improvements
It’s common to use home equity loans for home improvement projects because you’re reinvesting in your property. But if you don’t need a significant amount, a personal loan for home improvements may be less expensive and easier to apply for.
When you need to buy something big or expensive that you don’t have the cash for, a personal loan could solve your need.
Investing in Yourself
Personal loans may be able to provide funding when you start a business or need to learn new skills for your career. However, some lenders limit how you can use loan proceeds. For example, some personal loans don’t permit you to use them to pay for higher-education expenses.
Ideally, you have emergency savings available for life’s surprises. But sometimes there are no options besides borrowing. If you’re facing steep medical expenses or another emergency, a personal loan might make sense.
- A personal loan is a lump sum of money borrowed from a financial institution that can be used for almost any purpose.
- You typically qualify based on your credit history and income. These loans also don’t require collateral in most cases.
- Personal loans usually have fixed interest rates, relatively short repayment terms, and origination fees.
- You can obtain personal loans through banks, credit unions, online lenders, and specialized lenders.
- You can spend a personal loan as you see fit in most cases, but some lenders don’t allow personal loans to be used for higher education expenses.
4)What’s the Difference Home Equity Loans vs Personal Loans
While loan terms and requirements can vary by one lender to another , here the differences between home equity loans and personal loans.
- Collateral :No collateral may be necessary.
- Interest rate: Fixed rate.
- Upfront fees:Origination fees may be charged.
- Loan amounts:1,000 to 100,000 Dollars.
- Repayment terms: 1 to 7 years .
- Tax perks: None for personal expenses.
- Risk: Defaulting could have a negative effect on your credit.
4-2)Home Equity Loan:
- Collateral : Your home is the collateral
- Interest rate: Fixed Rate.
- Upfront fees: Closing costs may charged
- Loan amounts: Up to 85% of the equity you have in the home.
- Repayment terms: 5 to 30 years
- Tax perks: Interest may be tax-deductible if you use the loan to improve your home.
- Risk: Defaulting could put you at risk of foreclosure.
One of the differences between personal loans and home equity loans is the collateral backing. A home equity loan, often called a second mortgage, is a way to borrow a lump sum from your home equity. Since the collateral backing takes some of the risk away from the lender.
Personal loans are usually unsecured means they don’t require collateral backing. Instead, your signature on the contract is enough to get approved and receive funding. Good credit may be necessary to qualify for a personal loan, especially one with a competitive rate.
Interest rates for personal loans and home equity loans are often fixed, so you don’t have to worry about rate hikes or payment fluctuations. The exact interest rate you’ll receive on each type of loan will depend on factors such as your credit. However, interest rates on home equity loans may be lower than personal loans because those loans are backed by real estate.
Personal loans can have an origination fee that’s a percentage of your loan. Fees vary from lender to lender, and often from loan to loan. One may charge an origination fee up to 4.75% for its loans while another charges up to 8%.
A home equity loan isn’t free, either; you may encounter closing costs such as application fees, origination fees, credit-check fees, appraisal fees, and more.
Generally, lenders will offer up to 85% of your home equity in a home equity loan. The minimum you can borrow may also be high at least $35,000, for example.
To calculate home equity, subtract your home’s market value by your loan balance. For example, if your home is worth $400,000 and your home loan balance is $350,000, your home equity would be $50,000, and a lender may let you borrow 85% of this, or $42,500.
The minimum and maximum you can borrow for a personal loan varies from one lender to the next. You may be able to borrow as little as $1,000, and it’s common for lenders to provide maximum loans of $40,000 or $50,000. However, in some cases, you may be able to borrow up to $100,000.
Personal loan terms often range from 24 to 84 months. Home equity loan terms can last from five to 30 years, which could give you a more extended period to pay off the debt.
If you use a home equity loan to build or improve your home, the interest you pay on the loan may qualify for a tax deduction.1 Interest you pay on a personal loan for personal expenses is generally not tax-deductible.
Defaulting on a personal loan can hurt your credit if it’s reported to the credit bureaus. Missing payments on a home equity loan could have harsher consequences: Your lender could choose to foreclose on your home because of nonpayment.
5)Which Is Right For You
A personal loan will likely be the better option if you don’t own a home or don’t have enough equity to qualify for a home equity loan. It may also be a better option if you need a small loan, since personal-loan lenders may let you borrow a smaller sum.
On the other hand, if you own a home, you need a large loan, and you’re confident that you can make monthly loan payments, a home equity loan could be an affordable way to borrow money for a major purchase or debt consolidation.
No matter which option you choose, it’s important to shop around, review loan costs, and negotiate with lenders because this can help you find the best offer. A personal loan calculator can help you estimate payments based on the loan terms, interest rate, and amount you borrow.
6)Frequently Asked Questions
6-1)How do you get a personal loan?
You can apply for a personal loan with online and traditional lenders. The application process typically involves answering questions about yourself and your finances. Afterward, the lender does a credit check. If approved, you sign off on the loan terms, and funds may be directly deposited into your bank account.
6-2)What is the benefit of obtaining a personal loan?
Personal loans are installment loans that usually offer a set repayment schedule. If you keep up with payments each month, you know exactly when your loan will be paid off. This could be a better way to borrow money than relying on credit cards. Credit cards may come with a higher interest rate, and making just minimum payments could cause debt to spiral out of control.
6-3)How much can you borrow with a home equity loan?
You may be able to borrow up to 85% of the equity you have in your home. But factors such as your credit score, the home’s value, and your income may be considered when determining how much you can borrow.
Personal loans and home equity loans are both installment loans but how they work differ in many ways. Home equity loans are backed by your home while unsecured personal loans are not. Home equity loans may come with many different closing costs, while personal loans may have only one origination fee.
When deciding between the two options, consider how much you need to borrow, how much equity you have in your home, and how much it’ll cost you. Ultimately, the loan type that aligns with your goals the most while costing you the least is likely the better option.