Home equity loan vs personal loan: which is best?

If you need to borrow money for something that doesn’t fit neatly under another loan umbrella, like a car or an RV, you have a big choice to make: should you go with a home equity loan, or a personal loan? Both offer a lump sum of money today in exchange for steady payments over time. 

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Often, the best option boils down to your own comfort and ability to tap into your home equity, although there are clear signs that one might be better than the other. We’ll explore the differences between a home equity loan vs personal loan in this article, so you can be certain in your decision. 

How a home equity loan works

Home equity loans are a type of loan that’s disbursed as one large lump sum, to be repaid with equal monthly payments for several years. Lenders use the available equity in your home to secure the debt so that if you default, they can foreclose on your home in order to repay the loan. This is one of the biggest dangers of any home equity financing products, but in return, you’ll typically receive lower rates that can save you a lot of money over time. 

How a personal loan works

Personal loans are also a type of term loan that’s paid out as a lump sum, with steady payments each month for several years in a row. Unlike home equity loans, however, personal loans are not secured with any collateral, and that drives much of the differences between the two. Let’s look at some of those differences next. 

Home equity loan vs personal loan: Key differences

Functionally speaking, personal loans and home equity loans work in nearly identical ways. You get upfront access to a lump sum of funds, and you make the same monthly payment for the next few years until it’s fully repaid. Once you look under the surface, however, there are many differences between home equity loans and personal loans, and that information can help you make a better decision about what’s right for your family. 

Collateral

The biggest difference between a home equity loan vs personal loan is the collateral (or, the lack of it when it comes to personal loans). Collateral is something that a lender can repossess if you default on the loan, like a car or — in the case of a mortgage or home equity loan — your home. If you use your home as collateral, the lender will file a lien against your house until the debt is repaid. In exchange, you’ll be rewarded with lower interest rates since the lender has more confidence that they’ll be repaid in one way or another. 

Requirements

Most lenders are willing to lend up to 80% to 90% of your home’s value, minus your mortgage. New homeowners may not have had enough time to build sufficient home equity to even qualify for a home equity loan, or if they do, they may not be able to borrow much. 

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In addition, there are different credit score and debt-to-income ratio requirements for a home equity loan vs a personal loan. Lenders typically require credit scores of 680 for a home equity loan and 580 for a personal loan. Most lenders also calculate your debt-to-income ratio (i.e. what percent of your total monthly income goes to minimum debt payments) and prefer applicants with a DTI ratio under 43% for home equity loans and 35% for personal loans. 

Funding timeline

Personal loans are much faster to get than home equity loans. Many personal loan lenders can get your funds to you within a few business days, or even the same day in some cases. The process of getting a home equity loan is much more involved, however, since it involves a longer underwriting procedure to verify your home’s details. You can expect it to take up to six weeks before you see your money in the bank with a home equity loan. 

Term length

Personal loans typically carry shorter term lengths than home equity loans. Three- and five-year term lengths are common, but many lenders offer personal loans with term lengths ranging from one to 15 years. Home equity loans, in contrast, are typically available with term lengths ranging from five to 30 years in length. This allows you to spread your loan payments out more over time.

Borrowing cost

Home equity loans and personal loans have various costs associated with them, and the cheapest option isn’t always immediately obvious. For example, home equity loans typically charge lower interest rates, but charge higher fees in the form of closing costs. 

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In the second quarter of 2024, credit unions charged an average rate of 7.13% and 10.89% for a five-year home equity loan and a three-year personal loan, respectively. You’ll generally pay between 2% and 5% in closing costs for a home equity loan, however, while many personal loans don’t charge any fees at all. In addition, while home equity loans typically charge lower rates, they can also come with longer term lengths — and that can mean paying more interest overall compared to a personal loan. 

Tax implications

If you use a home equity loan to upgrade or improve your property, the interest you pay may be tax deductible. That’s not the case if you use a personal loan for the same purpose, however, or if you use a home equity loan for something else like consolidating credit card debt. It’s a good idea to talk to a tax professional to be sure of your case, however. 

How to choose between a home equity loan and a personal loan

If you have sufficient equity, income, and a high enough credit score to qualify for either option, it can be especially tough to make a decision. You’ll need to weigh several factors and see which ones you’re most comfortable with in the end.

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Here are some tips to help you decide. 

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Choose a home equity loan if:

• You want to borrow a larger amount 
• You’re confident you can repay the debt
• You want to take a longer time to repay it
• You want the lowest interest rate possible
• You don’t need the loan funds immediately
• You have some money set aside to pay for closing costs
• You’ll be upgrading your home and want to deduct the interest on your taxes

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Choose a personal loan if:

• You need the loan funds fast
• You want a shorter term length
• You only need to borrow a smaller loan amount
• You don’t want to risk losing your home to foreclosure
• You don’t want to pay any origination fees or other closing costs
• You’ll be using the loan funds for something other than home improvements

Alternatives to home equity loans and personal loans

An important part of any financing plan is to consider your full range of options since home equity loans and personal loans are far from the only tools available for the job. Here’s a quick rundown of other possible ways to finance your project:

Home equity investment

Home equity investments, or HEIs, are different from traditional debt. They work by sharing a slice of your home’s future equity with an investment company in exchange for a lump sum of funds today. You’ll repay the borrowed money in a similar lump sum at a later date, typically up to 30 years later or when you sell your home. They may be easier to qualify for since they don’t require any regular income or regular monthly payments. 

HELOC

Home equity lines of credit, or HELOCs, work similarly to home equity loans in terms of their qualification requirements and lien attachments. However, unlike a home equity loan, a HELOC features variable rates and operates as a line of credit that you can borrow from as you wish during a five to 10-year draw period with interest-only payments. You’ll then repay the HELOC during a repayment period lasting another 10 to 20 years. This offers added borrowing flexibility, but because your outstanding balance and interest rate are always changing, your monthly payment amount may shift from being nonexistent to becoming very large over the course of the HELOC. 

0% APR card

Some credit cards offer an interest-free introductory period lasting several months. During this time, you won’t pay any interest on purchases you make with your new credit card. This can be a great way to finance smaller purchases, especially if you're able to pay the entire balance off before the card starts charging interest. In this scenario, you wouldn’t owe any interest at all. 

Cash-out refinance

Another option is taking out a larger mortgage than you currently owe, known as a “cash-out refinance.” Your lender will return the difference to you as a lump sum of cash. This will reset your mortgage payoff progress and could result in higher overall interest charges by the time you pay off your loan, but because your payments are spread out over a longer period of time, each individual payment may be smaller. Lenders typically charge higher interest rates for cash-out refis, but if you’re able to qualify for a lower rate than you’re paying now, it could be a good option.  

Final thoughts

Choosing between a home equity loan vs personal loan isn’t always clear. In many cases, both options will work fine, it just depends on your comfort level with using your home as collateral for the debt. Many people are primarily concerned about the cost, however, and because there are so many factors that can impact your overall financing charges, we recommend using loan calculators to see exactly how much you’ll need to pay for any offers that you receive from lenders. 

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