Two methods for borrowers to choose. What are the differences?
If you’re a homeowner and need to borrow money for a renovation or other large expense, you may be considering getting a loan. Personal loans and home equity loans vary in a few ways. Read this guide to learn more about how they differ and how you can compare your options to make the best choice for your financial situation.
So, what is a home equity loan?
Home equity loans let you capitalize on the equity you have in your existing home. They enable you to utilize the capital gains of your house without needing to sell it. Your home equity is essentially the current value of your property minus the mortgage you owe.
For instance, consider that you own a house with a current market value of $500,000 of which you owe $150,000. By using the formula given above you will arrive at a figure of $350,000. This is the amount of equity you have in your home.
One thing you’ll need to remember is the fact you will not be able to use all the available equity you have in the property. Lenders usually offer a large percentage of the value of the property as a home equity loan.
What you need to know about personal loans
There are a number of different types of personal loans, such as car loans for purchasing vehicles, unsecured loans for a wedding, and so on. Here are a few points about different personal loans you can take out:
- Fixed rate personal loans have interest rates that don’t change throughout the loan term.
- Variable rate personal loans usually offer lower interest rates than their fixed counterparts. There is, of course, the catch that these rates could rise in the future.
- Unsecured personal loans give you access to funds even if you don’t have any assets to guarantee the debt.
- Secured personal loans require you to list a valuable asset as collateral as a guarantee.
Compare your personal loan options
Main differences between personal loans and home equity loans
|Personal loan||Home equity loan|
|Collateral required||None, if unsecured||Your home|
|Interest rate||Generally 2.19%-36.00%||Generally 3.74%-7.50%|
|Repayment period||Usually 1-7 years||Usually 20-30 years|
|Maximum loan amount||Can be up to $100,000||Typically up to 80% of your home value|
Which is better for you — a personal loan or home equity loan?
Both home equity loans and personal loans offer specific benefits. In particular, the former is useful when you have aggregated equity in your house, while the latter is useful especially if you don’t have any assets to guarantee the loan.
Home equity loans can also offer considerably lower interest rates than personal loans. This means that your monthly payment for any additional amount you withdraw on the home loan can be lower than if you took out a personal loan.
Keep in mind, however, that this interest is spread over a much longer term – 25 or 30 years compared to a common maximum of seven years for a personal loan. Because of this, you may end up paying more in the long run with a home equity loan.
For both personal loans and drawing on home equity, you may need to pay associated fees depending on the requirements of the lender. If you stay with your current mortgage lender, you may be able to avoid refinancing fees depending on the flexibility of your loan, but again, it depends on the lender and on the loan in question. Refinancing with a separate lender almost always carries additional fees and charges, so this will need to be taken into account.
Monthly payment vs. repayment period
Consider that you’re five years into your 30-year mortgage and you need a loan of $20,000. The interest rate on a secured personal loan is 8.9%, while your home loan offers 6.39%. To accommodate the additional debt, your monthly payments on your mortgage will increase by about $150, while you’ll need to pay $321 each month for seven years if you take out a personal loan. At this stage, the home equity loan seems worthwhile.
But over the life of your mortgage, you’ll end up paying a more interest on the home equity loan than on the personal loan because the repayment period is much longer and the interest rate is only a couple of percentages less.
In this scenario, even at a higher interest rate, the personal loan will be cheaper over the term of seven years as opposed to a home equity loan that stretches for the next 20-30 years at a lower interest rate.
One idea to make the home equity loan less expensive is to repay it at a faster rate than your existing monthly mortgage payments.
Things to consider when comparing personal loans and home equity loans
It’s worth noting that the longer you carry your debt, the more you pay in interest. That’s why choosing a loan with the shortest repayment term you can afford usually saves you money in the long run.
Be mindful that just because you have home equity, borrowing against it too frequently could be costly. Home equity loans are a viable option to consider if you’re a homeowner. But carefully examine the terms to see if a personal loan with a shorter repayment period might work for you.
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