Personal loans and home equity loans are popular financing options for home improvement projects, debt consolidation, and other major expenses. Home equity loans typically offer larger amounts with lower interest rates and monthly costs compared to personal loans. Interest payments on home equity loans used for buying, building, or improving a home may be tax-deductible. On the other hand, personal loans, which do not require collateral, can be a quicker option and may be more appealing if you anticipate financial changes in the near future.
If unsure about the loan amount needed, alternative options like credit cards or personal lines of credit could be considered, as they provide a credit limit rather than a fixed sum. Personal loans provide a lump sum of funds for personal expenses, with repayment terms typically ranging from two to seven years. Interest rates for personal loans usually fall between 8% and 36%, with fixed rates for the duration of the loan. Origination fees, varying from lender to lender, may also be charged.
Personal loans are generally unsecured, meaning no personal asset is at risk if the loan cannot be repaid. Loan terms are typically determined by factors such as credit score, credit history, and debt-to-income ratio. Personal loans are suitable for various purposes, such as debt consolidation, large purchases, emergencies, or minor home renovations.
In summary, personal loans are useful for financing expenses that are too significant for a credit card but do not require leveraging your home, such as small home improvements or debt consolidation.
In some cases, lenders can transfer funds to your bank account as early as the following day. If you apply with your own bank, you may receive the funds even sooner as you won’t have to wait for the transfer process.
When to Avoid Personal Loans:
Personal loans are typically more expensive and harder to qualify for than home equity loans since they are unsecured. Although there are personal loan options for borrowers with fair or poor credit, those with a credit score below 670 may find it challenging to secure a competitive rate.
✅ Advantages of a Personal Loan:
– No collateral required
– Borrow as little as $2,000
– Few or no fees
– Slightly lower credit requirements compared to home equity loans
❌ Disadvantages of a Personal Loan:
– Higher interest rates than home equity loans
– Limited loan term options
– Potentially high monthly payments for large loan amounts
– Not suitable for projects with unpredictable costs
Exploring the Concept of Debt Consolidation Loans:
Learn about what debt consolidation loans entail and how they can help you reduce your interest rates.
Understanding Home Equity Loans:
Home equity loans function similarly to personal loans but offer distinct benefits. These loans can be obtained through various financial institutions. By providing collateral, you can access lower interest rates, larger loan amounts, and extended repayment periods compared to personal loans. This often results in lower monthly payments, although selecting a lengthy term may elevate the total loan cost.
Determining Loan Amount for Home Equity:
To estimate your potential loan amount, subtract your existing mortgage balance from your home’s appraised value. Multiply the outcome by a loan-to-value ratio offered by your lender.
🏡 Example Calculation:
If your home is appraised at $350,000 and you owe $100,000 on your mortgage, your home equity is $250,000. With an 85% loan-to-value ratio, you could potentially borrow up to $212,500 from most lenders.
When to Consider a Home Equity Loan:
A home equity loan is beneficial for funding substantial projects such as home renovations. Similar to personal loans, home equity loans provide access to funds in a lump sum.
Home equity loans are a one-time sum and are ideal when you have a specific funding need. They are commonly used for home improvement projects, with the potential for tax-deductible interest if used to “buy, build, or improve your home,” as per the IRS. With lower interest rates compared to personal loans, home equity loans are favored by some individuals for covering significant expenses like college tuition or debt consolidation.
However, it’s important to exercise caution with home equity loans. If you are uncertain about your financial situation, or if you plan to use the funds for non-essential expenses like shopping or vacations, it may be best to avoid accessing your home equity. Failure to repay the loan could result in the loss of your home through foreclosure.
On the positive side, home equity loans offer lower rates, the ability to borrow larger amounts, and potentially lower monthly payments. But be mindful of the risks, including the possibility of losing your home if you default on the loan.
When deciding between a personal loan and a home equity loan, consider factors such as the amount needed to borrow, your credit score, monthly payment affordability, timing of fund disbursement, and the purpose of the loan. Seeking advice from a tax expert can also help determine if you qualify for any tax benefits related to the loan.
If you are uncertain about the exact amount you need to borrow, alternatives like home equity lines of credit (HELOCs) may offer more flexibility. Remember to carefully assess your financial situation and goals before committing to any loan agreement.
Access to a credit limit allows you to draw funds as needed for your project over a period of about 10 years. After the draw period ends, you repay the borrowed amount. For smaller expenses that can be repaid quickly, a credit card may be the most straightforward option, especially if you can pay off the balance within a month or two. If you have good credit, a new credit card with a 0% APR promotional period could offer a cost-effective financing solution for amounts repayable within 12 to 18 months.
Personal lines of credit provide access to a credit limit without requiring collateral, with higher limits compared to credit cards. They allow you to withdraw funds as needed, offering the flexibility to pay in cash rather than credit.
For more information on borrowing against your equity, FAQs on borrowing money, saving, and financial protection, as well as guidance on responsible borrowing and financial fit, explore our resources and personal finance guides. Additionally, find answers to common questions and discover how to earn, save, and grow your wealth.
Seeking a home equity loan without an appraisal? While many loans require an appraisal, some lenders offer no-appraisal loans using digital tools to evaluate your home’s value based on various factors. Explore options from digital lenders like Figure or LoanDepot in our comprehensive guide.
Wondering about borrowing 100% of your home’s equity? Learn the facts behind this common myth and understand the limits set by lenders based on your credit score and other factors in our guide to common home equity misconceptions.
Concerned about loan debt after your passing? Discover how loans are typically settled from your estate and whether your spouse may share responsibility based on local laws, protecting your loved ones after your death.
Looking to sell your home but unsure about necessary upgrades? Avoid “over-improving” by focusing on cost-effective updates rather than expensive renovations. Learn about seven upgrades to skip to maximize your return on investment before selling your home.
Considering using home equity to invest in a rental property? While possible, it’s essential to weigh the risks and benefits of using home equity loans or lines of credit for such investments. Understand the implications and explore alternative financing options through our resources.
You’ve already invested in your home, leveraging its appraised value. Utilizing a home equity loan opens up possibilities for how you can utilize the funds borrowed without restrictions. Delve into the advantages and potential risks associated with tapping into your home equity for secondary property acquisitions or investments.
Exploring the concept of a cash-out refinance sheds light on its function within the realm of mortgage loans. This financial maneuver involves replacing your existing mortgage with a new, larger one, enabling you to extract the difference between the two as cash. Essentially, this process resets both the total owed on your home and the repayment timeline. However, it is crucial to consider the associated costs before proceeding with refinancing your mortgage. For further insights on cash-out refinancing, refer to our comprehensive guide on leveraging your home equity.
References for further information:
– Publication 936 (2024), Home Mortgage Interest Deduction [PDF], IRS. Accessed on January 6, 2025.
– Finance Rate on Personal Loans at Commercial Banks, Federal Reserve Bank of St. Louis. Accessed on January 6, 2025.
About the author:
Anna Serio-Ali is a reputable personal finance specialist focusing on consumer and business financing. With a background as a certified commercial loan officer, Anna has contributed to over a thousand articles aimed at enhancing financial literacy among Americans. Her expertise spans personal, student, business, and auto loans, as reflected in publications such as Business Insider, CNBC, Nasdaq, and ValueWalk. Recognized as an Expert Contributor in Finance by the review site Best Company in 2020 for her contributions to Finder.
This article has been meticulously reviewed and edited by Kelly Suzan Waggoner.
