What is a home equity loan?
With a home equity loan, you borrow against the equity you’ve built in your home. 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 $150,000 in equity.
You can then borrow a portion of that equity — usually up to 80% — to spend however you’d like. You’ll receive your payment in one lump sum, which you’ll repay monthly with interest.
What is a personal loan?
A personal loan is not tied to your home equity. Instead, you apply with a bank, credit union or any other lender for a specific amount of money. If you are approved, you’ll receive this money in a lump sum, too, which you’ll pay back with interest. You can spend the money however you’d like.
Pros and cons of a home equity loan
Home equity loans come with several benefits that make them attractive to borrowers, including:
- Lower interest rates: Home equity loans usually come with interest rates that are lower than the ones attached to personal loans or credit cards. This makes home equity loans a more affordable way of borrowing money.
- Ability to borrow more: Because the amount you can borrow is tied to your home’s equity, you can typically borrow more money with a home equity loan. If you have $150,000 in home equity, you might be able to borrow as much as $120,000.
- Tax breaks: If you use your home equity loan to pay for improvements or renovations that increase the value of your home, you may qualify to deduct the interest that you pay on these loans from your income taxes, which may reduce the amount you owe on your taxes.
There are some drawbacks to a home equity loan, though, such as:
- Your home is your collateral: Because your home is your collateral, you could lose your residence to foreclosure if you can’t repay your home equity loan. Make sure that you can afford to repay your home equity loan monthly before applying for it.
- You’ll need to own a home and have equity: You can’t apply for a home equity loan if you don’t own a home. And if you don’t have enough equity, you won’t get approved.
- You’ll likely pay origination fees: Most lenders will charge some fees for home equity loans.
Pros and cons of a personal loan
Personal loans have several benefits, such as:
- You can get your money quickly: Lenders often provide personal loan funds within one day of approval. So, if you need money quickly, a personal loan might be a good choice.
- Many lenders don’t charge origination fees: Many lenders don’t charge origination fees for personal loans.
- No collateral: Personal loans are unsecured, meaning they don’t require collateral. You won’t lose your car or home if you fail to make your personal loan payments.
There are also some drawbacks to personal loans, including:
- Higher interest rates: Personal loans usually come with higher interest rates than home equity loans. That’s because they require no collateral, making them riskier for lenders.
- Can’t borrow as much: You typically can’t borrow as much with a personal loan compared with a home equity loan. Thus, these loans are better for borrowers needing smaller amounts of money.
- No tax breaks: Personal loans don’t come with the same tax breaks you might qualify for with a home equity loan.
Which loan type is best for you?
The best loan for you depends largely on how you’ll use the funds. If you need to pay for a major renovation or other big expenses and you own a home with equity, home equity loans are often the better choice because of their lower interest rates and tax breaks. For smaller infusions of cash, you might choose a personal loan instead.
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