Personal loan or home equity loan: Which is better?

The choice between a personal loan and a home equity loan is specific to your current situation and goals. (iStock)

If you’re planning to make a big purchase or consolidate high-interest debt, a personal loan or a home equity loan could be an excellent way to obtain the funding you need.

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Depending on which option you choose, though, you may get different requirements, repayment terms, interest rates and more.

Here’s what to consider to make the right choice for you.

Differences between home equity loans and personal loans

For the most part, you can use a home equity loan or personal loan for just about anything you want. But that’s where the similarity between the two loan types ends.

Here’s where they differ:

Collateral: Home equity loans are secured by the equity in your home, so if you don’t own a home or have significant equity, you may not meet the requirements to get one.

Personal loans, on the other hand, are typically unsecured, which means you don’t need to put up collateral to get approved. That said, some lenders offer secured personal loans, which you can collateralize with money in a savings account or another eligible asset.

Costs: Home equity loans typically charge much lower interest rates than personal loans. That said, you’ll need to pay some upfront costs to close on the loan, which can be expensive with some lenders.

While personal loans typically charge higher interest rates and some lenders charge origination fees, it is possible to get a loan without an origination fee, which can save you some money.

Repayment terms: Personal loans typically come with terms ranging from a few months up to seven years. With home equity loans, you could have between five and 30 years to pay off the debt. Depending on how much you want to borrow, one option may be better than the other.

Loan amounts: Home equity loans typically offer higher loan amounts than personal loans, though you may be restricted based on how much equity you have in your home.

Credit score requirements: Despite being secured, home equity loans still typically require good credit or better to get approved (a FICO score of at least 670) though you may be able to get one with fair credit. In contrast, you can get approved for a personal loan with any type of credit—though it’s important to note that bad credit personal loans typically carry exorbitant interest rates.

Advantages of personal loans and home equity loans

The biggest benefit of using a personal loan over a home equity loan is its unsecured nature. You don’t have to worry about putting up collateral with most options—and losing that collateral if you can’t make your payments.

Personal loans are also worth considering for smaller financing needs because they have short repayment terms and lower dollar amounts.

In contrast, home equity loans can save you money on large loan amounts because they typically carry lower interest rates. Also, you can find some lenders that offer home equity loans with low upfront costs.

Disadvantages of personal loans and home equity loans

If you’re considering a personal loan, the biggest drawback is the higher interest rate, especially if your credit is less than stellar. Also, some personal loans come with origination fees, which can add to your costs.

With home equity loans, because you’re essentially borrowing from your home, the biggest disadvantage is that if you can’t pay off the debt, you could lose your home. Also, some lenders charge expensive fees at closing, which can offset the benefit of a lower interest rate.

To pick the right loan for you, carefully consider your situation and needs and compare several lenders to get the lowest-cost option.