Maybe you want to remodel your kitchen. Or perhaps you’re looking to consolidate debt. Whatever the reason, home equity loans and personal loans are both options to borrow money to get the funding needed.

However, each one offers its own ideal use cases, advantages, and drawbacks. In this article, we’ll explore the differences between these two types of financing and how they can provide you with the cash you need when you need it most.

Understanding Home Equity Loans

Home equity loans give borrowers the option to secure a loan by using the equity built in their home as collateral. Equity is typically calculated as the difference between the value of your home and the amount of mortgage owed.

Unlike home equity lines of credit (HELOCs) which function more like a credit card, home equity loans are paid out in a lump sum. The loan amount typically maxes out at 80% of your home’s equity. So, for example, if your home is worth $200,000 and you have $100,000 remaining on your mortgage, you’d typically be able to get a maximum home equity loan of $80,000.

Home equity loans usually have a fixed interest rate. The average interest rate hangs right around 8.5%, and while they can be lower, they can also be as high as nearly 12%. Ultimately, your interest rate will be determined by factors such as credit score, the amount you want to borrow, your repayment terms, and if it’s your primary residence.

The repayment period typically ranges from 5 to 30 years. You’ll pay less interest with a shorter repayment period, but your monthly payment will be higher. Comparatively, longer repayment periods will have more affordable monthly payments, but will cost more over time.

Advantages and Drawbacks of Home Equity Loans

Home equity loans have a lot of advantages, but they’re not without drawbacks. Let’s take a deeper look at those key elements:

Advantages to Home Equity Loans

  • Potentially lower interest rates: Home equity loans often come with lower interest rates compared to other borrowing instruments because they’re secured against your home.
  • Tax-Deductible Interest: If you’re using your home equity loan to “substantially improve” your main home, the interest paid on a home equity loan may be tax-deductible, which can give you even greater savings.
  • Larger Loan Amounts: Since home equity loans are secured by the value of equity in your home, you may be able to borrow more than you could with a personal loan.

Drawbacks of Home Equity Loans

  • Risk of Foreclosure: By using your home as collateral, you are putting it at risk. If you default, you could face foreclosure and potentially lose your home.
  • Closing Costs and Fees: Home equity loans often come with closing costs and fees, which can add to the overall cost of borrowing.
  • Tied to Home Equity: Your borrowing limit with a home equity loan is tied to the amount of equity you have in your home. If your home’s value decreases, you may have limited borrowing options in the future.

Understanding Personal Loans

Just like home equity loans, personal loans allow you to borrow a large sum of money at once for starting a business, buying a car, or furthering your education. However, these loans don’t require any collateral, so they’re considered unsecured.

Because personal loans aren’t secured, they’re more risky for banks. This means that you’ll typically have a higher interest rate. Interest rates for personal loans can be either fixed, meaning the interest rate never changes, or variable, meaning the interest rate can change over time depending on market forces and other factors from the lender.

Personal loan interest rates range from 6% to 37%. Your interest rate will be significantly influenced by your credit history, income, and current debt-to-income ratio. Repayment periods for personal loans range from one to five years. Of course, the quicker you pay it back, the less you’ll pay in overall interest.

Advantages and Drawbacks of Personal Loans

Just like home equity loans, personal loans have their peaks and their pits:

Advantages to Personal Loans

  • No Collateral Requirement: Personal loans typically don’t require any collateral, making them accessible to a wider range of borrowers who may not own a home or have significant assets that can be used as security.
  • Quick Funding: Personal loans often have a faster application and approval process, so you can access funds quickly, sometimes within a week.

Drawbacks of Personal Loans

  • Potentially Higher Interest Rates: Since personal loans are unsecured, lenders may charge higher interest rates, especially if you have less-than-perfect credit scores.
  • Shorter Repayment Periods: Personal loans also usually have shorter repayment periods. While this can mean paying off the debt faster, it also results in higher monthly payments, which may be challenging to afford.

Comparing Home Equity Loans and Personal Loans

Now that you’re familiar with home equity loans and personal loans, let’s see how they stack up against each other.

Interest Rates and Repayment Terms

  • Personal Loan: Personal loans often have a shorter repayment term, but they come with higher interest rates and larger monthly payments.
  • Home equity loan: Home equity loans have a longer repayment period, lower interest rates, and more affordable monthly payments, but they often end up costing more over time.

Risks and Benefits

  • Personal Loan: Personal loans don’t require collateral, which means you need a decent credit score (typically around 700) to be approved. However, payments may fluctuate due to variable interest rates making it difficult to budget.
  • Home Equity Loan: Your credit score plays less of a role in your eligibility for home equity loans because your home serves as collateral. However, if you do miss payments, that means you could lose your home.

Eligibility and Requirements

  • Personal Loan: Applying for a personal loan usually involves filling out an online application or visiting a bank or lending institution. They typically require a credit score around 700, a consistent income, and a low debt-to-income ratio. Lenders may also consider factors such as employment history and credit history.
  • Home Equity Loan: A home equity loan involves a similar process to applying for a mortgage. You’ll need documentation such as proof of income, property valuation, and details about existing mortgage(s). This can make it a much more time-consuming process. You’ll also need to have significant equity in your home, usually at least 15-20% of the home’s value.

When to Choose a Home Equity Loan

  • Large Expenses: Home equity loans are a good option when you have large expenses such as medical bills or significant home renovations.

When to Choose a Personal Loan

  • Smaller, Short-Term Expenses: Personal loans are well-suited for smaller, short-term expenses such as consolidating credit card debt or covering emergency medical bills.
  • Avoiding Collateral Risk: Opting for a personal loan can be preferable when you want to avoid the risk of putting up your home as collateral. By not leveraging your property to secure the loan, you eliminate the risk of foreclosure in case of default.

The Bottom Line on Personal Loans and Home Equity Loans

Before committing to either type of financing, make sure you consider the following:

  1. Your Financial Health and Goals: Assess your financial health and future goals when deciding between the two types of loans. Consider factors such as your credit score, income stability, and borrowing needs.
  2. Applicable Interest Rates and Fees: Of course, interest rates play a significant role in choosing between loans. But factor in other fees such as origination fees, prepayment penalties, and closing costs.
  3. Do Diligent Lender Research: Before committing to a loan, take the time to research lenders and carefully review the terms and conditions. Compare interest rates, repayment terms, and customer reviews to make sure you’re getting the best deal. Reading the fine print can help you avoid a few surprises down the road too.

What if I Don’t Qualify for a Home Equity Loan or a Personal Loan?

If you don’t qualify for traditional financing options like home equity loans or cash-out refinancing, it can feel like you’re out of options. Fortunately, you may qualify for an alternative to traditional financing called a residential sale-leaseback. Here’s how it works:

Say you have debt that you want to pay off. You don’t have the money to do that right now, but you do have equity in your home. So, you sell your home to a real estate investment company and immediately start leasing it back. This gives you access to the equity in your home, allowing you to pay off your debt and stay in your home. Then, you continue leasing your home and eventually have the option to buy it back or move.

With SKYDAN’s residential sale-leaseback solution, you could have cash in hand in less than a month. That’s twice as fast as home equity loans and cash-out refinancing. Not only are sale leasebacks fast, but you may be able to access more cash than with traditional borrowing methods. This is because you’re tapping the equity in your home through a sale, not taking out a loan.

With SKYDAN, You Have Options

For too many homeowners, essential financing options are out of reach due to strict eligibility requirements. In this world where your options seem limited to expensive loans or are completely cut off due to eligibility requirements, a residential sale leaseback program like SKYDAN’s can seem too good to be true.

It isn’t. SKYDAN is different because we’re a real estate investment company — not a lender or a bank. That means we don’t care about:

  • Your credit score
  • Your payment history
  • Your debt-to-income ratio
  • Your income

All you need to qualify for SKYDAN’s program is equity in your home.

But don’t take our word for it; check out our reviews to see why our customers call us “the real deal.” And if you’re ready for more good news, see if you qualify today!