Home equity loan vs personal loan for debt consolidation

Debt can hold you back from reaching your goals, and you’re making the right decision if you’re looking for a way to get rid of it faster. Ironically, one of the best ways to get rid of high-interest debt — especially credit card debt — is to replace it with a debt consolidation loan. This lets you pay it off with a lower interest rate, which turbo-charges your ability to pay down your balance faster. 

‍

A “debt consolidation loan” isn’t a specific product, per se, so you’ll need to decide what type of product to use. Many people narrow their list down to two options and need help choosing between a home equity loan vs. personal loan for debt consolidation. Both can be good options, and we’ll help you decide which might be better for your particular scenario. 

Home equity loan: an overview

Home equity loans are actually second mortgages that you take out against the equity you have in your home. 

How home equity loans work

Most lenders will let you borrow up to 85% of your home’s value, minus the amount of your mortgage. For example, if you own a $500,000 home, you may be able to borrow up to $425,000. If you’re paying off a mortgage with a $125,000 balance, however, then you may only be able to borrow up to $300,000. 

‍

The process of taking out a home equity loan works similar to when you took out your first mortgage. It can take several weeks to go through the underwriting process, and it’s typical to pay between 2% and 5% in closing costs, including getting an appraisal. Most lenders also require credit scores of 620 or higher. 

‍

Your lender will also have a claim to your home in the form of a lien — just like your first mortgage lender — so it’s especially important to ensure you can always make your payment. If you default on a home equity loan, your lender can put your home into foreclosure. Additionally, if home prices drop, you could end up owing more on your home than it’s worth. Home equity loans must be paid off if you sell your home, too, which can cause additional complications when trying to find a buyer. 

Benefits of home equity loans

Despite these real setbacks, home equity loans have many advantages. They’re often among the lowest-interest loans that lenders offer, period, which is an especially important feature when it comes to consolidating your debt. 

‍

They can also be used to borrow very large amounts of money — up to 85% of your home’s value, with a paid-off mortgage — and you can take a very long time to pay them off, often up to 30 years. That can shrink your loan payments significantly. Plus, you can borrow additional funds for things like home improvement — in which case, the interest you pay may be tax deductible. 

Personal loans: an overview

If you’re unwilling or unable to tap into your home equity, another popular choice is a personal loan. 

How personal loans work

Personal loans are a type of unsecured debt, so they’re not attached to your home in any way. Instead, a lender will underwrite the loan based on your personal qualifications, rather than your home equity. Personal loan lenders don’t have as much leeway to ensure they get paid (by taking possession of your home if you default, that is), and so they typically charge higher interest rates to compensate for this risk. 

‍

Personal loans are typically available for smaller loan amounts and for shorter periods of time. In 2023, the average personal loan borrower took out just over $19,000, with most personal loan term lengths ranging from one to five years. Some lenders may charge origination fees, but it’s also common to find fee-free personal loans, with the only cost being the interest you pay each month. Personal loans may be available to people with lower credit scores, but the higher interest rates these loans charge can negate any benefit you get from consolidating your debt.

Benefits of personal loans

The main benefit of personal loans is that they’re much faster and cheaper to get, even if the interest rates are a bit higher. Some lenders even offer same-day funding with no fees. Additionally, you don’t need to worry about losing your home if you default. (There will still be consequences, such as credit damage and late fees, but it’s not as big of a risk.) 

‍

Personal loans don’t offer you the freedom of long term lengths, which means your payment may be higher — but it also means you’ll be out of debt, for good, a lot quicker. 

Home equity loan vs personal loan for debt consolidation

We’ve gone over several of the differences between home equity loans vs personal loans when it comes to debt consolidation. Now let’s put things together and make some recommendations.

When a home equity loan makes sense

Choose a home equity loan if:

• Your credit score isn’t the best
• You can afford to wait a few weeks for loan funds
• You don’t plan on selling your home anytime soon
• You’re absolutely certain you can always make on-time payments
• You’re financing a larger amount of debt with a longer term length
• You want to use some loan funds for home improvement purposes
• You want the lowest monthly payments possible, even if it takes longer to pay off
• You can pay upfront closing costs or find a lender that’ll let you roll them into your loan

When a personal loan makes sense 

Choose a personal loan if:

• You want funds fast
• You don’t want to risk losing your home
• You don’t qualify for a home equity loan
• You want to pay off the debt as fast as possible
• You’ll be selling your home before the debt is fully paid off 
• You don’t want to be stuck in an upside-down loan if home prices drop
• You’re financing a smaller amount of debt that you can pay off in one to five years

Other debt consolidation alternatives to consider

Home equity loans and personal loans aren’t your only debt consolidation options. It’s important to consider other types of loans, too:

HELOC

Home equity lines of credit (HELOCs) work similarly to home equity loans, but — as the name implies — they’re structured as a line of credit that you can use at will, not unlike a credit card. They charge higher interest rates than home equity loans, but you can repeatedly borrow money over the course of a five- to 10-year draw period, followed by a 10- to 20-year repayment period. You’ll only need to make interest-only payments during the draw phase, with the full balance being repaid during the repayment period. 

‍

A HELOC may be a good idea if you need to borrow money more frequently and don’t want to reapply for a new loan each time. It may also be better if you can’t pay much right now, but you’re certain that your income will increase later on. 

Home equity investment

Another option if you’re not able to make high monthly payments, home equity investments (HEIs) allow you to partner with an investor in order to cash out some of the equity in your home. There are no payments to make until you repay the funds you borrowed — plus a percentage of your home’s equity — in 10 to 30 years or whenever you sell your home or decide to settle your balance. 

‍

This is a good option if you can’t afford to make any payments, but you do trade off some certainty in knowing your actual borrowing costs since no one knows your home’s future value. HEIs are also a good fit for homeowners with credit challenges, as the requirements are far less stringent than a traditional home equity product. 

401(k) loan

If you have a workplace 401(k) you may be able to borrow against it with no credit check needed and automated payments that are taken out of your payroll. Plus, a 401(k) loan charges a low interest rate that even rivals home equity loans, and all of that interest gets paid back toward your retirement savings. 

‍

The downside is that the interest you pay yourself is typically less than you could earn if it stayed invested, and — a biggie — you must repay the entire balance in full as soon as you stop working for that employer, limiting your career options. If your employment is certain and you get lucky with a downturn in the market, however, this could work out better in your favor.

Personal line of credit

Like a HELOC, a personal line of credit lets you borrow money as you need it during a draw phase, to be repaid in full during a repayment phase. It’s unsecured, however, so it’s not attached to your home in any way — which also means it comes with higher interest rates. 

‍

A personal line of credit can be a good option if you’re looking for a more flexible way to borrow additional funds later, but you don’t want to pay credit card interest rates and you don’t want to risk losing your home if you default. 

Balance transfer card

If you’re consolidating credit card debt, one option is to open a new balance transfer card. These typically charge a balance transfer fee ranging from 3% to 5%, but in exchange, you’ll get an interest-free runway to make significant progress against your debt for many months after you open the credit card. Pro tip: divide your total debt by the length of your interest-free intro period to see how much you’d need to pay each month to fully get rid of the debt in this time frame, and then set up this amount on autopay if you can. 

‍

A balance transfer card can be an especially good option if you can pay off your entire debt during this interest-free period, and you can otherwise resist the temptation to spend more than you can afford with this credit card. 

Cash-out refinance

A cash-out refinance mortgage gives you a lump sum of cash in exchange for refinancing your home loan for a larger amount. It’ll come with the same closing costs and slower processing time, but it allows you to restructure your mortgage in addition to the debt you’re consolidating. 

‍

If you can get better terms on both types of debt than you’re already paying now (i.e., lower rates on your mortgage and the debt you’re consolidating), then it could be a win-win situation. Be mindful that it can reset the progress you’ve made in paying off your mortgage, however. 

FAQ

Is it a good idea to use home equity to consolidate debt?

Using home equity to consolidate debt is often much cheaper than with unsecured options like personal loans. However, most financial experts advise caution in doing so, because if you run into difficulties in paying back the debt, you could lose your home to foreclosure. 

What is a disadvantage of a home equity loan?

The biggest downside of home equity loans is that your lender can foreclose on your home if you default — an especially important point since many people who seek debt consolidation loans are already having a hard time making their monthly payments. 

What is cheaper, home equity or personal loan?

Home equity loans offer lower interest rates, but that doesn’t always mean they’re cheaper. After you factor in longer term lengths and higher fees, they may or may not be more affordable in the long run. The only way to know is to use a loan calculator to see which one offers the lowest monthly payment, vs. the lowest total loan costs. 

Final thoughts

Before you choose a home equity loan vs a personal loan for debt consolidation, take stock of your goals. Do you want to save as much money as possible, or do you want a lower monthly payment? The two aren’t always the same thing. 

‍

A 30-year home equity loan can offer the lowest monthly payments, but by the time you tally up all of the fees and interest you pay over the years, you could end up paying far more than with a five-year personal loan that requires a larger payment each month. 

‍

It’s a good idea to use online calculators to check the monthly payment amounts and total debt costs (including fees and interest) for all of your loan options, including keeping your debt right as it is. Then, compare the monthly payment to your budget to see if you can afford it. Only then can you make the best informed decision. 

‍

If you are looking to consolidate your debt with a financing solution with no monthly payments, consider a Home Equity Investment (HEI) from Point.

‍