Personal Loans vs. Home Equity Loans: The Better Option
If you’re a homeowner planning to remodel your home or a huge renovation project, then you’re probably considering getting a loan. The question is, which type of loan should you be getting? A home equity loan and a personal loan can both help fund your projects, but, they also vary in a few ways and the best option for you will ultimately depend on your financial situation.
What is a Home Equity Loan?
A home equity loan allows you to take advantage of the equity you have on your home without having to sell it. Your home equity is the current value of your property after the mortgage value is deducted. For instance, you have a house valued at $600,000 and you still owe $200,000, then you’ll have $400,000 in equity. Lenders commonly offer around 80% of the value of the property in a home equity loan, so your overall borrowing power may be nearer to $320,000.
What is a Personal Loan?
There are several different kinds of loans, each one serving a specific purpose. For instance, a car loan is for purchasing vehicles, a mortgage is for purchasing a home, a student loan is to fund for your education. A personal loan, on the other hand, holds a broader purpose as it can be used to fund just about anything. There are also different types of personal loans:
- Secured Loan – This type of loan requires you to list down all your valuable assets to serve as collateral or a guarantee for your loan.
- Unsecured Loan – This type of loan gives you easy access to funds without collateral to guarantee the debt.
- Fixed-rate Loan – This loan has a fixed interest rate throughout the term of the loan.
- Variable Rate Loan – This type of loan usually has a lower rate than its fixed counterpart, however, there is also a risk that it could surge in the future.
The thing about taking out a secured or an unsecured personal loan is that it usually only has a limit of up to $100,000. So, if you’re eyeing for a larger amount of debt, you’re better off securing a home equity loan.
But on the other hand, a personal loan could still cost you less even with the same interest rate. Large monthly payments combined with a loan tenure of five or seven years means that the interest you’ll be shelling out on a personal loan will be significantly lower than the rate for a home equity loan.
Which of the Two is a Smarter Option?
Each of these loan types offers specific benefits. A home equity loan is more favorable if you have aggregated equity on your home, while a personal loan can be helpful to you if you do not have any assets for a secured loan.
Home equity loans can also offer considerably lower interest rates than personal loans. This means that your monthly payment for any additional amount you withdraw on the home loan can be lower than if you took out a personal loan. However, the interest rate for this is spread out for at least 25 to 30 years, versus a personal loan with at least 5 to 7 years. This means that you might end up paying more in a home equity loan than a personal loan in the long run.
Some lenders also charge associated fees for both personal loans and home equity loans. Continuing with your current mortgage lending agency might help you avoid fees for refinancing depending on the lender and the loan flexibility. You also need to consider additional fees if you decide to refinance a loan from another lender.
Factors to Consider When Taking Out a Loan
Finding the right loan option can be confusing especially if there are so many available options but there's no proper guidance. You can use these factors to help you jumpstart through your decision-making course and find the option that best fits your needs:
1. The Purpose of Your Loan
The reason for your loan should be the topmost factor to consider when weighing in the pros and cons of a home equity loan or a personal loan. Taking out a personal loan is more feasible if your debt is currently unsecured so you don’t risk using your house as a guarantee. A home equity loan might be a more worthwhile option if you’re using the money on home renovation projects since they bring value back to your home and get a lesser interest rate.
2. The Amount That You Need to Borrow
Personal loans usually have a cap of up to $100,000. On the other hand, the amount approved for your home equity loan is also dependent on your equity, which is the amount of your property minus mortgages. Consider which of the two meets the amount that you need, if you don’t have enough equity to cover for the funds that you need, then you might want to consider taking out a personal loan.
3. The Turnaround Time
If you’re looking for quick funding, then traditional loans are your best bet. Home equity loans usually take a lot of time and are mostly considered a second mortgage against your home, which usually requires a ton of paperwork and additional waiting time for a bank to process it.
4. The Collateral Involved
Using your home as a loan guarantee can be risky. Failure to pay your debt could be tantamount to the foreclosure of your home leaving you with debt and no place to live. A home equity loan should only be borrowed if you’re sure that you have a secure source of income or funding to pay back your debt. Otherwise, it might be best to take out an unsecured personal loan.
5. The Interest Rate
The standard rule for loans is that the longer the repayment term, the higher the interest rate. That is why choosing a loan with the shortest payment period you can pay for generally saves you money in the long run.
Applying for a loan against your home’s equity too often could be pricey. It is important that you carefully study the terms to determine if it is more feasible for you to get a personal loan with a shorter repayment term.