In a Nutshell
Both home equity loans and personal loans give you a lump sum of money up front, which you pay back with interest in monthly installments. The main difference is that your home serves as collateral for a home equity loan, while personal loans often don’t require collateral.If you need to borrow money, you might consider taking out a home equity loan or a personal loan.
A home equity loan is a loan where your home serves as collateral. You borrow a set amount, and you usually repay pretty much the same principal and interest amount monthly until the loan term is up.
A personal loan is usually an unsecured loan that gives you a lump sum up front and, similarly, requires you to pay back the principal plus interest in monthly payments for a number of years.
Home equity loans and personal loans both have pros and cons. We’ll explore how these two loan types compare and look at some situations where it might make sense to choose one over the other.
- What is the difference between a personal loan and a home equity loan?
- Is it a good idea to take equity out of your house?
- Does a home equity loan count against your credit scores?
- Next steps: Questions to ask
What is the difference between a personal loan and a home equity loan?
The following table shows key details to compare.
How home equity loans and personal loans differ
| Home equity loan | Personal loan | |
|---|---|---|
| Collateral | Borrower’s home | Typically no collateral |
| Loan amounts | Usually capped at 85% of home equity | Typically $1,000 to $100,000 |
| Repayment terms | Monthly installments | Monthly installments |
| Fees | Upfront fees of 2% to 5% of loan amount | Possible origination fee of 1% to 8% of loan amount, rolled into loan |
| Tax advantages | Interest payments may be tax deductible if funds area used for home improvement | None |
| Risk to credit | Default could lead to foreclosure, which would seriously damage credit and hurt borrowing prospects | Default would damage credit, but consequences may be less severe than foreclosure |
Collateral
A home equity loan is a secured loan, meaning you have to put up collateral. In this case, the collateral is your home equity, or the value of your home minus the remaining balance on your mortgage. A home equity loan puts a lot on the line because if you don’t pay the loan back as promised, the lender can foreclose on your home to recover the funds.
In contrast, collateral often isn’t required for a personal loan. And you don’t usually risk losing your home or other property with an unsecured personal loan.
Some lenders offer secured personal loans, but these are typically backed by a savings account or car, rather than real estate.
Interest rates
Both home equity loans and personal loans typically have fixed interest rates.
Unsecured loans often have higher interest rates than home equity loans since they aren’t backed by property or savings.
The rate you might get for either type of loan will generally depend on your credit, income and the amount you’re borrowing. Shopping around and comparing rates will help you zero-in on the best possible offer for your situation.
Loan amounts
If you need to borrow a large amount, you’re likely better off going with a home equity loan. While lenders generally cap the amount you can borrow at 85% of your home equity, it’s common to see home equity loans for hundreds of thousands of dollars.
On the other hand, personal loans usually range from $1,000 to $100,000. And lenders may offer the highest loan amounts only to those with the strongest credit.
Repayment terms
Home equity loans often have longer loan terms available — up to 30 years — which can lower your monthly payments.
Personal loans usually have loan lengths between 12 months and 84 months.
Fees
To take out a home equity loan, you may need to pay for an appraisal to confirm your home’s value and for a title search to verify that you’re the owner of your home. Other fees may include an origination fee and a document prep fee.
In all, fees can often equal 2% to 5% of the amount you borrow.
When you take out a personal loan, lenders may charge an origination fee. This fee is usually 1% to 8% of your loan amount, and it’s generally taken out of your loan funds. That means you may not need to provide money upfront, but you’ll have to borrow enough to cover both the fee and whatever expenses you need the loan for.
Shop around and compare potential fees before you decide.
Tax advantages
You may be able to deduct the interest you pay on a home equity loan if you use the funds to renovate your home. But this tax incentive doesn’t apply if you use the money for something else, like paying for healthcare or a wedding.
The interest on a personal loan typically isn’t tax deductible.
Risk to credit
If you don’t repay either a home equity loan or a personal loan as promised, it can hurt your credit.
And if you default on a home equity loan, the lender could foreclose on your home.
A foreclosure would likely pull down your credit scores dramatically, and would stay on your credit reports for seven years. You almost definitely wouldn’t qualify for a new mortgage during that time frame.
Defaulting on a personal loan can also affect your credit reports and scores negatively. But the consequences likely won’t be quite as harsh as they would for defaulting on a home equity loan.
Is it a good idea to take equity out of your house?
There are pros and cons to borrowing against your home equity.
First, you’ll want to consider how much equity you have in your home. If you made a big down payment or have paid off a lot of your mortgage, a home equity loan might give you access to more cash than you’d be able to borrow with another loan type.
A home equity loan could be the better choice if you need a large sum, to pay for something like a kitchen renovation or an expensive medical procedure.
You’ll also need to ask yourself whether you can comfortably afford the payments on a home equity loan. If you can qualify for a lower interest rate on a home equity loan rather than a personal loan — and other terms are similar — the loan with the lower rate might be the better option.
But if you’ve been struggling financially and you’re worried about keeping up with payments, you probably shouldn’t risk your home.
And if you only need a small amount of money to cover a gap in your budget, a personal loan is likely a better option.
Does a home equity loan count against your credit scores?
Taking out either a home equity loan or a personal loan could cause a dip in your credit scores. Applying for a loan will usually generate a hard inquiry, which could bring down your scores slightly, temporarily. And taking on new debt will increase your credit usage, which can also pull down your score.
Whichever option you choose, making your payments on time adds to your payment history and might have a positive effect long term on your credit. And because both are installment loans, either one could improve your credit mix if you don’t already have debt in this category.
Next steps: Questions to ask
It’s a good idea to compare quotes from a few lenders before choosing a home equity loan or a personal loan.
And if you’re not sure which of these loan types is right for you, it might help to consider these questions:
- How does the cost of a home equity loan compare to the cost of a personal loan? Interest rates may be lower on a home equity loan, but both can come with fees that add to costs.
- Does one type of loan offer a more affordable monthly payment? No — it depends on the terms of each particular loan.
- How confident are you about putting up collateral? If your finances aren’t in great shape or if you’re borrowing for something that’s not critical, the risk of a home equity loan might not be worth it.
- Do you want to borrow a particularly large or small amount? A personal loan may be the better choice for smaller loans, while tapping into home equity can give you access to larger sums of cash.
And if you don’t know in advance how much you’ll need or if you plan to borrow repeatedly, you may instead want to consider a home equity line of credit, or HELOC. A HELOC is a form of revolving credit that allows you to borrow against your home equity multiple times, up to a credit limit (similar to a credit card).