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There are multiple loan options for someone seeking extra money to accomplish a goal, fund a project, or make a major purchase. Two such loans are personal loans and home equity loans. If you find yourself needing to choose between these loans, this article provides a comprehensive overview of the pros, cons and features of each loan and how to choose the one that’s right for you.
To find out if a personal loan or a home equity loan will suit your financial needs, read on.
Personal Loans vs Home Equity Loans
Before comparing the two loans, it’s important to first get an overview of what each type of loan entails. The sections below provide definitions, features, and the pros and cons of each loan.
What Is A Personal Loan?
A personal loan, as the name suggests, is a type of unsecured loan that you can use for nearly any personal purpose, be it a wedding, a dental bill, or consolidation of high-interest debts. The advantages and disadvantages of personal loans are outlined below.
The Advantages Of Personal Loans:
- No collateral needed: You can take out a personal loan without collateral.
- Flexibility: You can spend your loan on whatever you want.
- Fixed interest rates: This makes budgeting easier.
- A way to consolidate debt: A personal loan makes it easier to consolidate high-interest debts into a single, lower-interest payment.
The Disadvantages Of Personal Loans:
- Higher interest rates: The lack of collateral and additional flexibility comes at the cost of higher interest rates than usual. These can vary massively, anything from 6.99% to 46.96%. Your interest rate depends on your credit score, current debt, and income.
- Fixed repayment terms: You need to pay back your personal loan within a specified period (1-7 years).
- Too easy to take on debt: A small personal loan is relatively easy to get, which may incur more debt than someone can handle.
Requirements to qualify for a personal loan:
- A high credit score: The exact score will vary based on the lender, but they typically look for fair or excellent credit such as 660 or higher. Lower credit is accepted based on the size of the loan.
- Good income: The larger the loan, the more income you need.
- Steady employment: A lender will look to see if you have full-time employment. If you don’t provide collateral, having a full-time job proves you can repay the loan.
- Low debt-to-income (DTI) ratio: A low DTI demonstrates that you have extra money available for monthly payments.
Overall, a personal loan allows you to borrow money for any purpose without collateral, but how much you are allowed to borrow will vary based on your credit score, income, and debt-to-income ratio. Personal loans also have very high interest rates and strict repayment terms.
What Is A Home Equity Loan?
A home equity loan is a secured loan where your home serves as collateral. These loans are also known as second mortgages because they’re secured against your property, just like your original (first) mortgage.
The Advantages Of Home Equity Loans:
- Lower interest rates: Home equity loans come with lower interest rates than personal loans.
- Fixed interest rates: This makes it easier to budget for long-term repayment.
- Can be used for any purpose: Much like a personal loan, the lump sum of a home equity loan can be used for anything.
- Interest is tax-deductable: The interest you pay on a home equity loan can be tax-deductible, but only if you use your loan to buy or build property.
Disadvantages Of Home Equity Loans:
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- Two monthly payments: Although you take out a home equity loan based on your current mortgage, you will need to pay your mortgage and your home equity loan separately each month.
- Longer repayment terms: Repayment terms can be much longer than personal loans, some up to 30 years.
- Additional costs for setting up a home equity home: These fees include legal and appraisal fees.
- Failure to repay the loan results in foreclosure: If you fail to pay back your home equity loan, the lender will foreclose on the property you used as collateral, making this type of loan more high-risk.
How to qualify for a home equity loan:
- Have a current mortgage: You can take out a home equity loan with a maximum value of 80% of your current property.
Have good credit: The amount you can take out will vary based on how good your credit is. However, you generally need lower credit for a home equity loan than a personal loan since your current home secures the loan.
There is an exception to the above conditions. If you already own your home outright, you can take out a home equity loan against the value of your own house. This process is more straightforward as you most likely only need an appraisal to qualify for the home equity loan.
The Importance Of Credit Scores In Personal And Home Equity Loans
Your credit score is another essential factor influencing the decision between a Personal Loan Vs. Home Equity Loan. Generally, lenders are more likely to approve a home equity loan for borrowers with lower credit scores. This is because a home equity loan is secured by the home. On the other hand, personal loans are often harder to get if you have a low credit score.
Despite a home equity loan being easier to get even with lower credit, such a loan can put your home at risk if you fail to make the payments. If you have a low credit score and are unsure about your ability to repay the loan, it might be safer to consider other borrowing options.
Making the Right Choice: Personal Loan Vs. Home Equity Loan
The decision between a Personal Loan and a Home Equity Loan depends on several factors, such as your financial needs, credit score, and ability to repay a loan. If both loans are a viable option, which one do you choose? The following will help you decide which loan works better for you:
When to choose a personal loan:
- You need a smaller amount of money.
- You want to repay your loan over a shorter period.
- You don’t own a home for collateral.
- You don’t want to restrict what you spend your funds on.
- You have a high credit score and secure employment.
When to Choose a Home Equity Loan:
- You need a large sum of money.
- You prefer lower interest rates.
- You’re ok with a longer repayment term.
- You have a good credit score and secure employment.
- You are certain you can repay the loan.
Conclusion
Whether you choose a personal loan or a home equity loan, it’s vital to understand what you’re getting into. Borrowing money is a significant decision that may add years of payments and debt to your foreseeable future, so make sure this is the best option before choosing to do so. With enough research and careful consideration, you can pick the best loan for your financial goals and move forward with confidence – whether it’s a personal or home equity loan.
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