Personal Loan vs. Home Equity Loan: Which Is Right for You?

Personal loans and home equity loans are ways to borrow money. They can be for similar uses. However, there are important differences between the two. Which type of loan is the right fit depends on your situation.

Whether you want to consolidate other debt, finance a vacation, or pay for an expensive project, either a personal loan or a home equity loan may be an option.

Knowing some basic facts about the two types of financing can help you decide which is better for your situation. 

How personal loans and home equity loans work

Personal loans and home equity loans both involve borrowing money and repaying it in equal installments over a predetermined amount of time. Beyond those basics, there are some important differences.

How home equity loans work

A home equity loan is a second mortgage. The loan uses equity in your home as collateral. Equity is the value of the home minus what you owe on any existing mortgage. If you don’t currently have a mortgage, then the entire value of your home is equity.  

Collateral helps guarantee the loan in case the borrower fails to repay it. If a borrower defaults on a home loan, the lender has a legal claim to equity in the property, up to the amount owed on the loan. 

Being able to use equity as collateral has a few big advantages. The extra security that your collateral offers a lender may:

• Help you get approved for a loan
• Qualify you for a lower interest rate compared to an unsecured loan
• Enable you to borrow more money, depending on how much equity you have in your home
• Allow you to get a longer repayment period if you need more time to repay

Balanced against all those benefits is one big potential drawback: a home equity loan puts your house on the line. That means you risk losing it if you can’t keep up with all your loan payments. 

How personal loans work

Personal loans are not secured by equity in your home, but they may or may not have other forms of collateral.

Collateral is anything of value you can put up to guarantee repayment of the loan. You don’t have to put up collateral to get a personal loan, but it can help. 

A loan with collateral is called a secured loan. One without collateral is called unsecured. Secured loans may be easier to qualify for and have lower interest rates.

An unsecured personal loan will be based entirely on your credit history and financial situation. If both are good, you may not need collateral to get a cost-effective loan.

Comparing home equity loans to personal loans

The use of your home as collateral is the biggest thing that distinguishes a home equity loan from a personal loan. The availability of such substantial collateral has an effect on the loan terms. 

Below is a general description of how home equity loan terms compare with personal loan terms. Note that in either case, there can be a wide range of different terms. There may be some overlap between the terms you could get for a home equity loan and those you could get for a personal loan. Typically though, there are important distinctions between the two that are described below.

Home equity loans can be bigger

Personal loans can range anywhere from a few hundred dollars to tens of thousands. A small number of lenders offer unsecured personal loans for up to $100,000.  The average personal loan is $10,000. 

Home equity loans are often much larger than $10,000. Generally, the upper loan limit is 80-90% of the amount of equity a homeowner has, depending on the lender. Some lenders offer home equity loans up to $1,000,000. 

Home equity loans usually have a longer term (length of loan)

The term is the length of time the borrower has to repay a loan. For personal loans, the term generally ranges anywhere from 1 to 10 years. 

Home equity loan rates can be much longer. As with primary mortgages, the terms on home equity loans may extend up to 30 years. However, shorter terms are available. A shorter loan will reduce the total amount of interest you pay over the life of a loan. 

Some personal loans have a higher interest rate

For both home equity loans and personal loans, the interest rate available varies depending on your credit score and other factors. Home equity loans offer lower interest rate because the collateral (your home) lowers the risk of loss for the lender. That’s true of secured personal loans, too. For an unsecured personal loan that is based solely on your credit and finances, someone with stronger credit might pay 2-10% APR while someone with weaker credit might pay 25-35%.

There is some overlap in the rates on home equity and personal loans. Generally speaking, expect to see these differences:

• Home equity rates tend to be lower than personal loan rates
• Home equity rates tend to be offered in a narrower range from high to low. Personal loan rates tend to vary more depending on the qualifications of the borrower.

Home equity loans always require collateral

A home equity loan requires that equity in the home be pledged as collateral. Because of this, the homeowner must have more equity than the amount they wish to borrow. Lender’s don’t usually loan 100% of your equity. 

Personal loans may be secured or unsecured. Offering collateral could increase your chances of approval or help you qualify for a lower rate. 

Some common forms of collateral you might borrow against are:

• Certificate of Deposit account
• 401(k) account
• Vehicle title Stocks and bonds
• Jewelry, antiques, or artwork

Approval and loan requirements

Some of the approval and loan requirements are the same for personal and home equity loans. These include:

• Meet the lender’s credit requirements Some lenders require a higher credit score than others. Search for loans online and find a few that offer online prequalification without hurting your credit score (once you officially apply, your score could drop by a few points). Enter your basic information to find out which lenders have loans that might work for you. 
• Ability to repay. This will usually be based on some version of debt-to-income (DTI) ratio. The DTI ratio compares your required debt payments to your income. If your debt payments are about a third or less of your income, you would be considered a very strong candidate for a loan. A smaller loan is going to be easier to qualify for because the income requirements are lower. 

Time to fund a loan

While funding may be a matter of days for a personal loan, it’s more likely to be several weeks for a home equity loan. 

Some lenders, as noted, offer funding of personal loans within hours or days. This may not always apply, but if you are well-qualified, your application is straightforward, and you are borrowing a modest amount, the turnaround time can be very quick. 

Getting money from a home equity loan is more complicated. Because equity in a property is being used to secure the loan, there are additional steps, such as an appraisal and title search.  

Those added factors in a home equity loan application can also add to the fees involved in getting one. As a result, a personal loan may be more cost-effective for smaller amounts.

Why choose a home equity loan over a personal loan?

The three biggest advantages of a home equity loan over a personal loan are:

• Lower interest rates
• Larger amounts
• Longer time to repay

Why choose a personal loan over a home equity loan?

Here are the three biggest advantages of a personal loan over a home equity loan:

• Homeownership not required
• Not all personal loans require collateral
• Approval and funding can be same day

When to consider other types of financing

Depending on what you’re trying to accomplish, you may have even more possible solutions to consider:

• HELOC. A home equity line of credit uses equity in your home as collateral, but instead of borrowing one lump sum, you can tap into a line of credit as you need to over a period of time. It might be a good solution if you aren’t sure exactly how much you’ll need, such as for a remodel. 
• Credit card. A credit card is generally a better tool than a loan if you anticipate being able to pay off the balance quickly. A zero-percent balance transfer card can be a good tool if you are trying to consolidate and pay off debt.

Debt consolidation alternatives. If you need help handling existing debts, a debt management plan or debt settlement may be other options to consider. These are not loans, but they are ways of making your financial obligations more manageable.