Personal loans and home equity loans can be used to make home improvements, consolidate debt, pay medical bills and for many other purposes.

These are common financing options when you have a big expense coming up. In fact, Experian’s latest Consumer Credit Review report found that 22% of American adults had a personal loan.

However, personal loans are generally better if you’re early in your mortgage, while home equity loans are ideal if you’re looking for the lowest interest rates.

Get pre-qualified

Answer a few questions to see which personal loans you are pre-qualified for. The process is quick and easy, and it won’t affect your credit score.

How do personal loans work?

Personal loans are offered by online lenders, banks and credit unions. These loans can be used for a variety of needs, from financing a major expense to consolidating debt. Borrowers with good to excellent credit scores are most likely to be approved and find a low interest rate. But that doesn’t mean applicants with average to low credit scores can’t get personal loans.

Applying for a personal loan can be as simple as filling out an online form and providing electronic documentation, but since each lender structures their loans differently, it’s always a good idea to shop around before making a decision. Compare quotes from multiple lenders and see which one offers a loan amount that suits your needs, along with a repayment term and interest rate that suits your budget.

Once you’re approved for a loan, you can usually receive funds within days and you’ll make fixed monthly payments on the loan until it’s paid off.

How do home equity loans work?

A home equity loan is also called a second mortgage. The equity in your home is the value of your home minus what you owe on your mortgage.

Home equity loans allow homeowners to use the equity they have accumulated in their home to take out loans. They generally allow borrowers to make payments over a period of five to 15 years, although terms vary. Most lenders will allow you to borrow up to 85% of your home’s combined loan-to-value ratio.

Plus, a home equity loan has one big advantage over a personal loan: lower interest rates. This is because the loan uses your home as collateral, so the lender may have a claim on your home if you fail to repay your loan.

Unlike a personal loan, the application process for a home equity loan is a bit more complex. Although you can often apply online, the process usually takes a few weeks as an appraisal of your property must take place.

When you receive a home equity loan, you get the full amount all at once and have to pay it back in fixed monthly installments.

When to choose a personal loan

A personal loan may be a better choice than a home equity loan in certain scenarios:

  • You have a lower expense: Although you can find smaller home equity loans at local credit unions, most banks set a minimum of $10,000 or more. Personal loans, on the other hand, can allow you to withdraw as little as $1,000.
  • You don’t want to risk your home: Personal loans are generally unsecured, so you cannot lose your home or other property in the event of default.
  • You don’t have much equity: If you don’t have enough equity in your home, you may not qualify for a home equity loan at all.
  • You have excellent credit: Having excellent credit will qualify you for the lowest personal loan rates, some of which can hover around 3%.

Howard Dvorkin, CPA and president of Debt.com, says if you’re looking to pay off credit card debt, a personal loan is a better option. “If someone has multiple credit cards – totaling over $5,000 – and a credit score that will qualify them for a reasonable interest rate, a personal debt consolidation loan may be the right option for them,” he said.

When to Choose a Home Equity Loan

In some cases, a home equity loan may be the best option available. You may want to consider a home equity loan if:

  • You have a lot of equity: If you’ve built up significant equity in your home, you may be able to borrow up to $500,000, far more than you would with a personal loan.
  • You don’t have the best credit score: Since a home equity loan is a secured loan, it may be easier for people with below average credit to qualify – just be aware that you won’t get the best interest rates.
  • Looking for low fares: Home equity loan rates are generally lower than personal loan rates, which means your monthly payment will be smaller and you will pay less to borrow money.
  • You want to renovate your house: If you use the funds from your home equity loan for renovations, you can deduct the interest paid on your taxes.

Alternative Borrowing Options

Personal loans and home equity loans aren’t the only ways to borrow a large sum of money. If you have other financial needs in mind, try one of these alternatives.

Home Equity Line of Credit (HELOC)

A HELOC works like a credit card. You get a line of credit secured by your home and can use these funds for almost any purpose. HELOCs often have lower interest rates than other types of loans, and the interest may be tax deductible.

Similar to a home equity loan, you borrow against the available equity in your home, which is used as collateral. You can borrow as much as you want, as often as you want during the drawing period, usually 10 years. You can replenish your available funds by making payments during the draw period. At the end of the drawdown period, you will begin the repayment period, which is usually 20 years.

To qualify for a HELOC, you need the equity in your home. Similar to a home equity loan, you can often borrow up to 85% of the value of your home, minus the outstanding balance of your mortgage. When you apply, lenders will look at your credit score, monthly income, debt-to-equity ratio, and credit history.

Most HELOCs have variable interest rates, which means your rate can fluctuate over the life of your loan. As interest rates increase, your payment also increases. In addition, as with credit cards, the risk of overspending is higher than with a fixed amount loan. Without some discipline and budgeting, you could end up with large payments during the repayment period.

Credit card

Credit cards offer many advantages. Making payments on time each month can improve or boost your credit rating, and many credit cards offer cash back or frequent flyer miles that you can redeem on certain airlines. They are as convenient as cash and can be used as a financial safety net in times of emergency.

Credit cards have a few drawbacks, however. Some credit cards charge high interest rates on cash advances and balance transfers. Missed or late payments can damage your credit and there is always a risk of credit card fraud on your account. Additionally, some cards have high annual fees (from as low as $25 to over $1,200), you may incur surcharges from merchants when paying with your credit card, and additional fees may apply. quickly accumulate.

Home Improvement Loans

The main distinction between home improvement loans and home equity loans is that home equity loans are secured and home improvement loans are generally unsecured personal loans.

Due to the unsecured nature of home improvement loans, they generally carry higher interest rates, but they are ideal for borrowers who are planning small or medium-sized renovations and do not want to use their property or their house as collateral.

When it comes to home renovations, however, Dvorkin advises sticking with a home equity loan. “It adds value to a home, instead of putting it at risk, and helps consumers build long-term equity,” he says. Additionally, interest used on home improvement projects may be tax deductible if you use the loan to buy, build or improve your home.

The bottom line

The choice between a personal loan and a home loan depends on your financial needs. Both types of loans have pros and cons to consider before applying, but both are good options if you need to borrow money. Either way, take the time to compare all of your loan options, interest rates, fees, and repayment terms before submitting your application.

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