Personal Loan vs. Home Equity Loan

What are personal loans?

Personal loans are often used to finance home-related purchases, but that's not all that they're good for. In fact, you can get a personal loan for just about anything, from buying a boat to funding a home renovation.

More often than not, personal loans are used to pay for a home improvement project, cover a large purchase that's not covered by any other type of loan, to pay for unexpected expenses, or to consolidate debt.

These kinds of loans tend to be unsecured, meaning they aren't backed by your car or home like an auto loan or mortgage might be. Instead, you'll receive the money you need upfront and make payments over time with similar fixed payment terms as any other kind of loan.

The downside to not having to worry about any kind of collateral (like you would with a car or home loan) is that the interest rates tend to be higher on personal loans. That said, they're still more affordable than what you'll find for credit cards, which is why many consumers look to personal loans when they want to consolidate high-interest rate credit cards.

Personal loans can vary in amount, ranging from $1,000 to $100,000.

What are home equity loans?

A home equity loan is a secured loan that is based on the value of your home. Often referred to as a "second mortgage," a home equity loan allows you to receive a lump sum of cash that is paid back over time. Usually, this is done with a fixed interest rate.

Here's where things get tricky. The loan is based on your equity – in other words, the difference between what you currently owe on your mortgage and what your property is worth. Since your house will be serving as the collateral, interest rates are lower on these kinds of loans than on unsecured personal loans.

How do you get a personal loan?

You can get a personal loan from most banks, credit unions, and online lenders. In fact, your current bank or credit union should be your first stop when you're looking for this kind of loan. Here, you'll meet with a loan officer who can review your credit score and financial history to determine your loan terms and eligibility.

At credit unions, the qualification process for personal loans tends to be less rigorous than it is for banks. Interest rates here tend to be cheaper, too, but you have to be a member in order to do business there. Neither credit unions nor banks charge loan origination fees.

However, you should not just shop offers from your current bank or credit union. Online lenders can offer competitive personal loans. As an added bonus, you may receive funds faster as well. If you do not have time to shop and apply with your current bank or credit union you should go straight to an online lender. Online platforms such as Acorn Finance can allow you to check offers from top national lenders with no impact on your credit score. Within 60 seconds or less you can receive personal loan offers up to $100,000, giving you the freedom to choose the offer that is best for you.

If a bank, credit union, or online lender isn't a viable option for you, you can also turn to a non-banking financial company, like a payday lender, peer-to-peer lender, or another non-bank entity. These companies often approve borrowers that typical banks will not.

Be careful if you choose to apply for a personal loan from one of these sources – although they have higher approval rates, they often charge hidden fees and higher interest rates. No matter what kind of loan you choose, make sure you review the type and amount of interest charged, if there are any prepayment penalties, whether the loan is secured or unsecured, the monthly payment, loan term, and so on.

Read the fine print before you sign!

How does a home equity loan work?

You can take a home equity loan out with a variety of repayment terms, but usually these are for a period of 5 to 30 years.

To apply, you'll need to go through many of the same processes you did when you applied for your mortgage.

This kind of loan is ideal for a homeowner with significant equity in his or her home, as well as one looking for a lower interest rate and potential tax deduction.

How do interest rates compare for personal loans vs. home equity loans?

Home equity loan rates fluctuate usually between 3% and 12%.

Personal loans are much more variable. These are rarely lower than 6% but can be as high as 36% – sometimes, higher than what you'd pay on a credit card.

How much of a home equity loan can I get?

Although the exact amount will vary depending on your lender, you can usually borrow around 80% to 85% of your home's value – minus whatever you still owe on your mortgage loan.

To figure out how much of a home equity loan you'll qualify for, take your home's value and multiply it by the percentage of the value your lender will allow you to borrow. That's the maximum amount of equity you can borrow. Take this number and subtract the remaining balance on your mortgage.

The resulting number is representative of how much of a home equity loan you can take out.

Does a home equity loan require an appraisal?

In order to get a home equity loan, you'll need to have an appraisal – in most cases. Although this isn't required by all lenders, most lenders prefer an appraisal to protect itself from the risk of default.

In some cases, you may be able to bypass this. Some lenders will use county assessment records and automated valuation models to get a comparable price for your home.

This is often done with a recent appraisal that has been done, usually within the last 180 days. If it's a low loan-to-value percentage that's being requested, your appraisal might be waived, too – and if you're requesting a home equity loan from the lender who already holds your mortgage, you might be able to get out of the appraisal process on a good-faith gesture, too.

How is the value of your home determined for a home equity loan?

The appraisal is the most important component that lenders will use to determine your home's value.

To increase your likelihood of being approved for the full amount, you should make your home look its best. The appraiser is going to be taking photos as part of the evaluation – so something as simple as a fresh coat of paint or minor repairs can increase the value dramatically.

Appraisers will also collect information on comparable properties nearby. If there are lots of similar homes that have sold recently in your neighborhood, your home will likely be compared against them to determine its value.

What can you use a home equity loan for?

Home equity loans can be used for a variety of expenses. While most people use this kind of loan to fund a major renovation or home repair, they can even be used to finance expenses completely unrelated to your house.

Some common uses of home equity loans include:

Funding a vacation

Consolidating or paying off credit card debt

Paying for a wedding

Funding a student loan

Starting a business

Paying major medical bills

Funding an emergency fund

Purchasing large items like vehicles

Funding investments

Can you get a home equity loan without income?

It is rare for a borrower to receive a home equity loan without any income – although it can sometimes be done.

Lenders like to see that you'll be able to repay the loan you're taking out, so if you're unemployed, your chances of being approved for a home equity loan are slim.

That said, some lenders will consider you if all other factors are in your favor – and if you have a co-signer who can guarantee payment for the lender in the event that you default.

Are there tax incentives for home equity loans?

In some cases, there are tax incentives for home equity loans.

If you use the funds from your home equity loan to fund renovations that will "substantially improve" it, you can deduct interest on loans of up to $750,000. It's important to note that, in order for the money to be deductible, it has to be spent on the property for which the equity is the source of the loan.

In other words, you can't spend money from a home equity loan on another property (or another expense, like a vacation or wedding) and receive tax benefits.

What are the pros and cons of home equity loans?

Home equity loans are a good idea if you have a low current mortgage interest rate and you are interested in making major renovations or home improvements – for which your interest will be tax-deductible. You'll get a much lower interest rate on this kind of loan than you will on a personal loan or credit card, and since the rates are fixed, it will likely make budgeting much easier.

That said, there's less flexibility in a home equity loan, especially if you aren't interested in using the loan for something home-related. You pay interest on the full loan amount and since the loan is secured by your house, missed payments can jeopardize your home.

Where can you get home equity loans?

You can typically get home equity loans from any other lender that offers traditional mortgages. There are also outside lenders you can turn to, like Spring EQ. Here, you'll be able to access up to $500,000 from your home to pay off debt, remodel or renovate, and more. Unlike home equity loans from traditional banks, these can be ready to fund in as little as 11 days!

How much of a personal loan can I get?

Check with your lender to find out how much of a personal loan you might qualify for. Usually, they range from less than $1,000 to $100,000. At Acorn Finance you can check personal loan offers up to $100,000, depending on credit score.

What can you use a personal loan for?

Personal loans can be used to consolidate debt. They can also be used to pay for:

Medical bills

Student debt

Collection agency debt

Tax debt

Immediate home repairs

Repaying debts to friends or family or helping a loved one in a crisis

Wedding expenses

Divorce

Vacation

Vehicles and expensive consumer goods

Moving expenses

Funeral costs

Veterinary expenses

Small business expenses

Can you get a personal loan without income?

As is the case with a home equity loan, you may be able to get a personal loan without income, but it's going to be much more difficult. Remember that income doesn't necessarily have to be from a job – if you get alimony, disability or unemployment benefits, or even child support payments, this may still count as income that raises your chances of getting a loan.

If you can't get a personal loan on your own, again, you may be asked to reapply with a cosigner.

Are there tax incentives for personal loans?

Personal loans are not tax deductible. In most cases, you can only deduct the interest from a personal loan if you are spending the proceeds on taxable investments, qualified higher education expenses, or business expenses.

What are the pros and cons of personal loans?

The biggest advantage of a personal loan is that it allows you to access cash quickly – like in the event of an unexpected home repair. Getting approved for a personal loan takes far less time than it does for a home equity loan. In some cases, you can get a personal loan in as little as a few hours.

Plus, if you're not planning on borrowing a lot of money, a personal loan makes sense. Going through the entire underwriting process for a home equity loan of just $10,000 might seem a little silly – and many home equity loan lenders won't even let you go through the process for small amounts. In that case, a personal loan is the way to go.

Finally, personal loans are often considered less risky than other kinds of loans, like home equity loans. Because your home is not at stake, you won't have to worry about losing your home should something go awry.

Where can you get personal loans?

You can get personal loans from banks, credit unions, online lenders, and other non-bank entities like peer-to-peer lenders. Online lenders are convenient and can sometimes offer the most competitive rates and terms. To check offers, click here.

What are other financing options?

In some cases, neither a personal loan or a home equity loan will do the trick for you. In that case, you may want to consider a HELOC. Also known as a home equity line of credit, this loan is more like a credit card in that you'll have a revolving line of credit. You'll be able to get money to use over a period of time rather than a lump sum all at once.

Unlike a home equity loan, you won't pay interest on your money until you start to use it. The funds are still secured based on the amount of equity you have in your home, but you can pay back the money you've spent and re-use it if necessary.

Paying with a credit card is another option. This works well for very small purchases, like a small DIY home improvement project. In some cases, you may be able to make interest-free purchases on your card with special promotional offers – and then pay off the balance before interest starts to accrue. Again, this is a good option if you're financing just a small purchase.

A cash out refinance is yet another alternative but it only makes sense when the current mortgage rates are lower than what you're already paying. You'll refinance your mortgage for more than what you owe, then cash out the rest to pay for whatever it is you're trying to fund. Since there are closing costs and appraisals involved, it's important to really fine-tune your budget and consider your goals before choosing this option.

When in doubt, you can always split a major project or expense up between multiple types of financing. You can apply for a personal loan for half the expenses – then cover the rest with your savings. Choose the option that works best for you – after all, regardless of your circumstances, there are plenty of financing options to choose from!