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The Pros and Cons of Personal Loans and Home Equity Loans

When to Get a Personal Loan or a Home Equity Loan

Personal Loans vs. Home Equity Loans: When to Get One

Consolidating debt. Making home improvements. Covering unexpected expenses. These are among the most common reasons people take out loans. Both a personal loan and home equity loan can provide the funding you need. Here is what you need to know to determine which one is right for you.

What Is a Personal Loan?

Getting a personal loan is straightforward. You figure out how much you need. Lenders will review your application and set terms if you are approved. You can expect your funds up to $100,000 within 30 days. When it comes to repayment, the interest and payment totals are fixed.

People with strong credit scores typically get the best personal loan options. That is important because personal loans are unsecured. As a result, lenders will offset their risk by charging higher interests. A strong credit score means you can borrow at a lower rate, which can range from 5 to 36 percent.

Personal loans are ideal if you are consolidating your debt into a single payment or investing in home improvement. They are not as great for medical expenses or financing a vacation. Make sure to compare personal loan rates before settling on one. The best personal loan is often the one with the lowest APR.

What Is a Home Equity Loan?

If you are a homeowner, you can use your home equity to fund upcoming expenses. Your equity is the difference between your home’s price and what you currently owe on the mortgage. If you have a $350,000 home and $150,000 remaining in mortgage payments, your home equity is $200,000.

Lenders typically approve home equity loans up to 85 percent of the equity. Borrowers receive a lump sum, which makes the loan ideal for immediate and large expenses. They also come with favorable interest rates compared to personal loans.

Home equity loans can be risky because they require collateral. In this case, the collateral is your home. If you default on payments, the lender may foreclose on your property. You should only consider a home equity loan if you can pay off the loan in full.

Home Equity Loan
Personal Loan
Terms 5 - 30 years 1 - 5 years
Collateral Yes No
Interest Rates 3 - 12% 5 - 36%
Tax Break on Interest Yes* No
Fast Approval & Funding No Yes**
Loan Limits ~ 80% of Home Equity ~ $1,000 - $100,000
*for home improvements
** for qualified applicants

Your Other Loan Options

Home Equity Line of Credit (HELOC)

A HELOC is a second mortgage that also lets you access your home equity. There are two distinct phases: the draw period and the repayment period. During the draw period, you can use the equity to fund expenses in the same way you use a credit card. During the repayment period, you have to pay back the principal plus interest.

Lenders prefer borrowers to keep at least 15 percent of their home's equity. HELOCs provide financial flexibility, and you only pay compound interest on the money you use. However, like home equity loans, your house is collateral. If you cannot keep up with payments, you may lose your house.

Credit Cards

Credit cards are a double-edged sword. On the one hand, they provide immediate funds and come with perks, such as rewards points. On the other hand, if you cannot stay on top of monthly payments, you're existing debt will quickly escalate.

Credit cards have a higher cost of borrowing than a traditional loan. As of January 2020, the average interest rate for a credit card is 19.02 percent, while personal loans are 9.41 percent. Defaulting on payments is an easy way to dig yourself a financial hole. If you plan on using a credit card, make 100 percent sure you can avoid paying interest.

Unsecured Personal Line of Credit

A personal line of credit lets you withdraw funds up to $100,000 for a set period. Once you take out money, interest starts accruing. Like a credit card, you will have to pay back the principal plus interest each month.

Personal lines of credit are usually unsecured. That means the borrower doesn’t put down any collateral. If they default on their payments, the lender has few recourses for action. Some lenders will allow borrowers to put down collateral in exchange for better terms.

The Bottom Line

Deciding between a personal loan and home equity loan depends on your situation and preferences. Do you have strong credit and need a short-term, immediate loan? Then a personal loan is probably a better fit. Or, do you need a large sum of money even if your house is collateral? In that case, go with a home equity loan.

Either way, take your time. Make sure to compare your loan options, interest rates, and repayment terms. If you need help, United financial advisors are here to guide you.