Learn the big differences and how you can use each to invest in your next home.
How do personal loans differ from mortgages?
There are two major differences between personal loans and mortgages. A personal loan is unsecured, whereas a mortgage uses your house as collateral — if you default on a mortgage, you could lose your home. A personal loan is also for a much smaller amount, which makes it difficult to buy a house with one. Instead, a personal loan is better suited for other costs, like improvements after the house is purchased and new furniture to decorate your space.
The main differences between personal loans and mortgages
|Interest rate||Varies by lender, usually between 3.99% to 36%||Varies by lender, but can start as low as 3.2% for a fixed-rate mortgage|
|Maximum loan amount||Up to $100,000, depending on the lender and your eligibility||High-cost area limit goes up to $954,225 for a single unit|
|Loan term||Typically between 1 to 7 years||Typically 15 or 30 years, but can be as short as 10 years or as long as 50 years|
|Repayment frequency||Usually monthly repayments||Usually monthly repayments|
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What are the benefits of personal loans and mortgages?
- No tax implications. You won’t be charged income tax on the amount you borrow unless the debt is forgiven by the lender.
- No down payment. Unlike mortgages, many lenders don’t require you to provide any cash up front when you apply for a personal loan.
- Negotiate repayments. You may be able to negotiate your repayments if you’re facing financial hardship or an emergency.
- Lower APR. Because the loan is secured with your property, lenders are more likely to offer a low APR.
- Prequalification. You can get prequalified and go house shopping with a clear picture of what you’ll be paying every month.
- Tax advantages. You can deduct your interest, mortgage points and your real estate taxes from your yearly income tax calculations.
What are the drawbacks of personal loans and mortgages?
- Short repayment terms. Most lenders have repayment terms lasting one to seven years.
- High interest rates. Since you’re not providing collateral, you’ll likely have a higher interest rate and will need to pay proportionately more in interest over the life of your loan.
- Small loan amounts. You’ll only be able to borrow $100,000 if you have impeccable credit. Otherwise, your funding will be limited.
- Foreclosure. If you fail to make payments and default on your mortgage, you may face foreclosure and lose your home.
- Amount paid. Despite low interest rates, mortgage loan amounts tend to be very large. This means that by the end of your repayment period, you’ll likely have paid tens of thousands of dollars in interest alone.
- Payment fluctuations. With an ARM, the payments you make can fluctuate drastically depending on the market.
Which borrowing option is better suited for me?
The better option will depend on your needs as a borrower. Mortgages are the most common option because they’re meant for real estate. You’ll have the choice between a few different options, including mortgages with fixed rates and other mortgages that change with the financial environment. In addition, buying a home outright on $100,000 or less is nearly impossible in most parts of the country. Some lenders will allow you to use a personal loan as a down payment, but otherwise, you’ll have a hard time covering the costs of a purchase.
However, if you’re looking to fill that new home with some furniture, a personal loan is an option to consider. Personal loans can be used for many purposes, which makes them useful when it comes to home improvements or other big purchases.
Using a personal loan as a down paymentGenerally, you won’t be able to use a personal loan as a down payment because lenders will ask for proof that you have the funds available to pay yourself. However, if you have no existing debt, some lenders may allow you to use a personal loan and consider it in your debt-to-income ratio when reviewing your application.
If you can’t afford a down payment and won’t be able to use a personal loan, there may be a first-time home buyer program available in your state to help you afford the down payment.
What’s the difference between a personal loan or a remortgage?
Remortgage is another term for refinancing, which is the process of paying off your current mortgage with a second mortgage through a new lender, usually at a lower interest rate or with better terms. Unless you only owe a small amount on your current mortgage and have excellent credit, a personal loan likely won’t be a comparable option.
A remortgage is ideal for specific goals — like lowering the monthly payments on your house or switching from an ARM to a fixed-rate mortgage — while a personal loan is designed to cover costly purchases without restrictions. Approval for both usually depends on a decent credit score and a positive credit history.
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Personal loans can be good for a wide variety of things, but they’re not necessarily the best for funding the purchase of a home. Mortgages are exclusively used for purchasing real estate and can generally offer you better terms. Before you make any big financial commitments, you should talk with a financial advisor and compare your options. Whichever you choose, have your finances in order and understand the full impact of each type of loan when you apply.