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Home equity loan vs personal loan

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What is the difference between a home loan and a personal loan?

A home equity loan and a personal loan both offer one-time lump sum payments that must be repaid in installments over an agreed period of time. However, the main difference is that home equity loans are a specific form of secured loan in which the borrower’s home is used as collateral. Personal loans, on the other hand, may or may not be secured by collateral and are a much broader and varied category.

Since personal loans tend to have a less intensive approval process than a home equity loan, they can generally be quicker and easier to obtain. Although home equity loans generally take longer to be approved, they tend to offer a lower interest rate than a personal loan and potentially a higher loan amount. Before pursuing either option, however, it is important to consider the amount you need and the purpose of your loan.

Key points to remember

  • Both home equity loans and personal loans offer one-time lump sum payments to be repaid in installments over a specified period of time.
  • A home equity loan is a type of secured loan in which the borrower’s home is used as collateral, while personal loans can be secured or unsecured with collateral.
  • Personal loans tend to be faster and easier to approve, while home equity loans require a property appraisal and a longer application and approval process.
  • Home equity loans generally offer a lower interest rate than personal loans, but both generally offer lower interest rates than credit cards.
  • Both loan types can be used for a variety of purposes, although home equity loans can offer larger amounts, depending on the equity in the borrower’s property.
  • Interest payments on personal loans are not tax deductible, while interest payments on home equity may be if the loan is used to “purchase, build, or substantially improve the home. of the taxpayer guaranteeing the loan”.

Structure and purpose of the loan

In a home equity loan, money is borrowed using the value of your home (more specifically, the equity in your home) as collateral. The FTC defines home equity as “the difference between what you owe on your mortgage and the amount you could get for your home if you sold it.” This is why a home equity loan is sometimes called a “second mortgage”.

Many personal loans are unsecured, but there are secured personal loans that can be secured by collateral such as a certificate of deposit (CD), stock, vehicle, or savings.

Personal loans can be used for a variety of purposes, including consolidating credit card debt, paying off higher interest rate debt, major expenses (like a major appliance or vacation), or even establishing or improving your credit score.

Home equity loans can also be used for a variety of purposes, such as debt consolidation, large one-time expenses, or educational or medical expenses. Keep in mind that a home equity loan is a lump sum payment, so a home equity line of credit (HELOC) may be better suited to situations (like a long home improvement project or starting a business). a business) where a large amount of ongoing funding is needed, or money will be needed continuously over a period of time.

When considering which loan to access for financing in the specific case of home renovations or improvements, a home equity loan may be a better option than a personal loan. Indeed, in most cases, interest paid on personal loans is not tax deductible; however, home equity interest payments are – provided the home equity loan is used to “purchase, construct or substantially improve the home of the taxpayer who is securing the loan”.

Loan application and approval

Personal Loan Application and Approval

When applying for a personal loan, the following will generally be considered by the lender:

  • Your credit score and credit report
  • Your income and employment status
  • Any debt you may have (in particular, your debt-to-income ratio (DTI))
  • The interest rate permitted by applicable state law
  • Collateral (if applying for a secured loan)

The amount of the loan and the length of the repayment term are also important factors that will determine the interest rate of the loan. Personal loan amounts can range from a few hundred dollars to $100,000.

Keep in mind that personal loans may also include fees such as:

  • Assembly costs
  • Fees for processing documents and administrative formalities
  • Credit insurance (optional)
  • Disability insurance (optional)
  • Non-declaration insurance (for secured loans)
  • Late penalties

It usually takes between one and seven business days to get a personal loan, depending on the lender.

Home Equity Loan Application and Approval

When you apply for a home loan, a lender will calculate your loan-to-value ratio (LTV) or your combined loan-to-value ratio (CLTV) to determine the amount of money they will allow you to borrow. This calculation basically answers the question: if the house is sold, will it cover the amount owed by your original mortgage and this additional loan, and by how much? It is also an important factor in determining the interest rate for your loan. Usually, the lower your LTV, the lower your interest rate.

In order to determine the value of your home, there is usually an appraisal process, similar to that of a conventional mortgage. This may incur various fees and closing costs. Your income and credit history will also be taken into consideration. The maximum amount you can borrow is usually around 80% of the equity in your home. Keep in mind that most lenders have a minimum amount they will lend in this type of loan agreement, usually around $10,000.

Interest rate and payment terms

The interest rate of a personal loan can be fixed or variable, and can be lower than that of a credit card, but generally higher than that of a home equity loan (especially in the case of personal loans not guaranteed). In general, evaluate a personal loan interest rate by comparing it to the national average: if it is lower, it is a good sign. On a personal loan, the interest rate can vary from 6 to 36%, depending on your credit history.

The duration of personal loans can vary from around 1 to 5 years, sometimes more. It is advisable to choose the shortest loan term for which you can afford monthly payments.

Home equity loan interest rates are usually fixed and tend to be lower than personal loans and credit cards because the home is used as collateral. However, the risk here is that if the loan is not repaid, the lender may repossess and sell the home to cover the remaining debt. It also means that if the value of your home goes down, the amount you may owe will exceed the value of the home.

Home equity loan interest rates can range from 1.89 to around 11.75%, depending on the term and equity of the property and the borrower’s credit history, with the average being around 4 at 5 %.

Home equity loans can range from 5 to 30 years.

other considerations

When considering a loan, it’s important to shop around and compare the terms and offers offered by different banks, credit unions, and financial companies. Under the Truth in Lending Act (TILA), lenders are required to disclose the following information before signing any loan agreement so that consumers can understand and compare different offers:

  • The total amount you borrow
  • Amounts of repayments and their deadlines
  • How much does it cost to borrow money (called “finance charges”; includes interest and any fees applicable to the loan)
  • Annual Percentage Rate (APR)
  • Any penalties that may apply in the event of late payment
  • The consequence(s) of not repaying the loan and the actions the lender can take
  • Any penalties that may apply in the event of early repayment of the loan

Try using a loan calculator to get an idea of ​​how much you’ll end up paying.

Does a home equity loan have lower interest rates than a personal loan?

Usually, yes. On a personal loan, the interest rate can vary from 6 to 36%, depending on your credit history. For home equity loans, the interest rate can be as low as 1.89%, going as high as around 11.75% (depending on the term of the loan), with the average hovering around 4-5%.

Does a personal loan have lower interest rates than a credit card?

Personal loans may have lower interest rates than a credit card, but not necessarily. This will largely depend on the length and type of loan (secured or unsecured, for example) as well as the borrower’s credit history.

What is the difference between a personal loan and a home loan?

The biggest difference between a personal loan and a home equity loan is the structure – a home equity loan is a specific type of secured loan in which the borrower’s home is used as collateral. While both offer lump-sum, one-time payments, the amounts for each can vary and the approval process is different (usually much shorter, in the case of personal loans).

The essential

When considering a personal loan rather than a home equity loan, it’s important to consider whether either option is best for your financial situation (or whether another type of credit, such as a line of credit or a refinancing option, could be more favorable). Use a loan calculator to get an idea of ​​how much you’ll potentially be spending. Given the purpose of the loan and the amount you will need, research the best options between different lenders and make sure you understand the entire agreement and associated fees before signing anything.