Home Equity Loan vs. Personal Loan: Which is Right for You?

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There are benefits to borrowing against your home when the option exists. But there are drawbacks to consider, too.

There are benefits to borrowing against your home when the option exists. But there are drawbacks to consider, too. 

There will likely come a point in your life when you need to borrow money, whether it's to address an expensive home repair or fix the car you need to get to work every day. Ideally, the cash to tackle that problem should come from your savings account. 

But if you don't have an emergency fund, you may have no choice but to borrow that money instead. That could mean you find yourself in a position where you have to decide between a home equity loan and a personal loan. The question is: Which is the better option?

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What is a home equity loan?

A home equity loan is a sum of money you borrow where your home is used as collateral. Equity is defined as the portion of your home you own outright, and it's calculated by taking your home's value and subtracting your outstanding mortgage balance. So if you owe $100,000 on a home worth $160,000, you have $60,000 in equity. 

To qualify for a home equity loan, you'll generally need at least 20% equity in your property. But once you have it, getting that loan is pretty easy because your home is used as collateral to secure the loan. This means that if you fail to make your loan payments, your lender can recoup its money by forcing foreclosure on your property and collecting the proceeds from its sale. 

What is a personal loan?

A personal loan is a loan that doesn't require you to put up assets as collateral. Rather, you can qualify for a personal loan by virtue of having a good credit score. Banks and credit unions are a good option for personal loans, and the amount you qualify for will depend on how strong your credit is and what your existing debt payments look like.

Which is the better choice?

If your credit isn't great, a home equity loan could be an easier ticket to borrowing money, provided you have the necessary equity in your home. Even if your credit is strong, a home equity loan may be easier to qualify for if you're looking to borrow a larger sum. 

Furthermore, the interest rate you'll pay on a home equity loan is generally lower than what you'd pay on a personal loan. And if you use that money for home improvement purposes, you may have the option to deduct your home equity loan interest on your tax bill 

On the other hand, a personal loan could take a lot less time to finalize, which means you'll get access to the money you need sooner. And while you'll generally pay higher interest on a personal loan than you will on a home equity loan, it'll be cheaper than the interest you'll typically pay on a credit card. 

Another thing to consider: If you fail to pay back your home equity loan, you could risk losing your home. If you fall behind on a personal loan, your credit score could take a major hit, but you don't take on the risk of losing the roof over your head. 

Ultimately, you'll need to weigh the pros and cons of both options to decide which financing choice is the better one for you. And no matter which one you decide on, be sure to keep up with your payments to avoid unwanted consequences.

The Ascent's Best Personal Loans for 2021

The Ascent team vetted the market to bring you a shortlist of the best personal loan providers. Whether you're looking to pay off debt faster by slashing your interest rate or needing some extra money to tackle a big purchase, these best-in-class picks can help you reach your financial goals. Click here to get the full rundown on The Ascent's top picks.