Home Equity Loan vs. Personal Loan: What’s the Difference?

If you’re contemplating some long-awaited home improvement projects or are looking for ways to pay emergency bills, you may be trying to figure out the best way to get the extra money you need. A credit card or savings account may work for minor renovations or a few small bills, but for more significant expenses, a personal loan or home equity loan might better suit your needs.

These two types of loans can help you get the money you need, but they work in different ways. Understanding how they're different can help you make smart decisions about your finances. From definitions to the pros and cons of each, let's explore home equity loans vs. personal loans below.

What is a home equity loan?

Like personal loans, home equity loans are also installment loans. Sometimes called “home improvement loans,” because homeowners often use them to finance household renovations, they use the borrower’s home as collateral. (If you’re unfamiliar with the concept of collateral, check out what collateral is and how it works.)

While popular for home improvement projects, it’s important to note that, like personal loans, home equity loans can be used for nearly whatever you’d like, subject to the exclusions the lender discloses.

How does a home equity loan work?

You need more than a home to qualify for a home equity loan. You need home equity, which is simply the difference between what you currently owe on your mortgage and the current value of your home.

For example, say you bought your home for $200,000, and, according to an appraisal you’ll likely need for a home equity loan, it’s now worth $250,000. If you’ve already paid $50,000 of your mortgage, you have $100,000 in equity.

Using your home as collateral, you can now borrow against that equity. It’s important to note that lenders typically limit these loans to 85% of your home’s equity.¹

Pros and cons of home equity loans

Pros

• Lower interest rates compared to personal loans
  
• Higher loan amounts available
  
• Potential tax benefits on interest payments
  
• Longer repayment terms

Cons

• Risk of losing your home if you default on the loan
  
• Lengthy approval process
  
• Closing costs and fees may apply

What is a personal loan?

A personal loan is a type of installment loan you may use for a variety of reasons, including debt consolidation, home improvement projects and emergencies. They can either be secured or unsecured loans, and they generally feature predictable monthly payments over a scheduled period of time.

How does a personal loan work?

When you apply for a personal loan, you'll submit an application detailing your financial information. The lender will assess your creditworthiness to determine the offer amount, interest rate and repayment terms. Personal loans typically have fixed interest rates and monthly payments over a set timeframe.

Pros and cons of personal loans

Pros

• Collateral may not necessarily be required
  
• Quick approval process
  
• Fixed interest rate and monthly payments
  
• For a secured loan, the applicant’s creditworthiness and the value of eligible collateral is considered.

Cons

• Limited loan amount
  
• For an unsecured loan, eligibility is based on the applicant’s creditworthiness.

What’s the difference between a home equity loan and a personal loan?

While there are certainly differences between home equity loans and personal loans, let’s start with similarities. As mentioned above, personal loans and home equity loans are both installment loans. You get your money in one lump sum and pay off your loan in pre-established monthly installments over a set amount of time. You can also use either loan for a variety of reasons.

As for the differences between these loans, here are the most notable distinctions:

• A personal loan can either be secured or unsecured, while a home equity loan is always secured, using your home as collateral. This means that if you fall behind on your payments for any reason, you may risk potentially losing your home.
  

• Since home equity loans are secured with high-value collateral, i.e., your home, personal loans are often smaller than home equity loans.
  

• Interest rates are typically higher for personal loans than they are for home equity loans. The terms of a personal loan — including interest rate — are based on a variety of factors, including credit history, income, expenses and the availability and value of collateral (if applicable).
  

• While the personal loan process can take a matter of days, sometimes even just hours, the home equity loan process typically takes about two to four weeks.²
  

• Some personal loans require an origination fee — a one-time fee to cover loan processing costs — whereas all home equity loans include a number of closing costs. Many of these costs, such as title searches and notary fees, are similar to those you may have paid when taking out your initial mortgage.³
  

• As banks respond to changing economic conditions, they might also change their policies on issuing home equity loans.⁴ When this happens, it may be easier, and faster to seek out a personal loan.
  

Is a home equity loan or a personal loan the right option?

This really depends on your circumstances. If you need a large amount of money for a major home improvement project, cash to pay unexpected emergencies, or to help finance your child’s college education and have a significant amount of equity built up, a home equity loan is the way to go. A personal loan, on the other hand, cannot be used for education expenses.

If you don’t require a large loan — perhaps you’re interested in household bill consolidation or have a smaller home improvement project you’d like to check off your list — a personal loan may better suit your needs.

Take time to consider your options

Do your research, then give yourself enough time to weigh your options. Whether it’s home renovations or paying off bills, when you find the right loan and the right lender, you’re one step closer to achieving your goals.

If you’re thinking about tackling a home improvement project, explore how a personal loan for home improvement can help your home feel new again.

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Sources:

1. Federal Trade Commission. “Home Equity Loans and Credit Lines.” FTC.gov. https://www.consumer.ftc.gov/articles/0227-home-equity-loans-and-credit-lines (accessed May 15, 2020).
2. Lock, Cheryl. “What You Need to Know about Home Equity Loans.” Credit.com. https://www.credit.com/blog/5-things-to-know-about-home-equity-loans-76738/ (accessed May 18, 2020).
3. Bankrate. “How Much Are Home Equity Loan Closing Costs?” https://www.bankrate.com/home-equity/home-equity-loan-closing-costs/ (accessed June 21, 2024).
4. American Banker. “JPMorgan halts home equity loans due to coronavirus.” Americanbanker.com. https://www.americanbanker.com/news/jpmorgan-halts-home-equity-loans-due-to-coronavirus (accessed May 19, 2020).

*This article has been updated in 2020. Jessica, Kim Gallagher contributed to this post.