Personal Loans vs. Home Equity Loans: Which Should You Choose?

Home equity loans and personal loans are both ways to borrow money. But they come with some significant differences. 

Personal loans are a type of unsecured loan, meaning that there is no collateral backing them up. With an auto loan, your car serves as collateral. If you fail to make your payments, your lender can repossess your car. With a mortgage loan, your home acts as collateral. If you stop paying, your lender can foreclose on your home. 

Personal loans have no collateral. Because of this, they tend to come with higher interest rates than secured loans. When you take out a personal loan, your lender will check your credit and income. If you are approved, you will receive your funds in a lump sum payment. You’ll then repay that with interest with regular monthly payments. 

A home equity loan is different. You can only apply for one if you own a home with equity. Equity is the difference between what you owe on your mortgage and what your home is worth. If your home is worth $400,000 and you owe $250,000 on your mortgage, you have $150,00 in equity. You can then borrow a percentage of that equity, usually up to 80%. If you have that $150,000 in equity, you can typically borrow up to $120,000. 

You can use that money however you’d like. As with a personal loan, you’ll receive payment in one lump sum and then repay it with regular monthly payments with interest. 

Pros and cons

What loan type is right for you? That depends. 

If you need to fund a large project: A home equity loan might make sense if you need to pay for a large home-improvement project. That’s because you can usually borrow larger amounts with home equity loans than you can with a personal loan. 

You want the lowest interest rate: Because home equity loans are secured, with your home acting as collateral, they are less risky to lenders. Lenders will typically charge lower interest rates than they do for unsecured loans, such as personal loans. This makes borrowing money with a home equity loan less expensive than doing it through a personal loan. 

You’re funding a home-improvement project: If you use the money from a home equity loan to pay for a home improvement that improves the value of your home, you can write off the interest that you pay on this loan on your taxes. This could save you significant money come tax time. You can’t write off the interest if you use a home equity loan for any other purpose. 

You’re worried about losing your home: If you can’t make your home equity loan payments, your lender can foreclose on your home. Lenders can’t do this with a personal loan. If you miss your loan payments, lenders can assess you late fees or send your debt to collections. But they can’t take your home.

You need a small amount of money to cover an emergency: If you need quick funds to pay for an unexpected car repair or if you need money to replace your home’s furnace, a personal loan might be a better choice. You can usually close on a personal loan and receive your money quickly, often on the same day on which you apply. It also makes more sense to take out a personal loan if you are only borrowing a small amount of money. Many personal loans come with no origination fees, while you might have to pay closing costs when taking out a home equity loan. Those closing costs might not be worth it if you are only borrowing a small amount of money.