Personal loan vs equity loans

Aug 30, 2022

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There are a myriad of options for financing large purchases, two of the most common include personal loans and equity loans. The one that’s right for you ultimately depends on how soon you need it, how soon you want to pay it off, and what stakes you’re comfortable with.

Qualifications and approval

Equity loans

Equity loans are based on how much equity you have in your home–or how much of the mortgage you have paid off already. Most equity loans require you to have at least 20% equity to qualify. It can be a lengthy process to be approved for equity loans and come with additional closing costs such as appraisal fees.

Personal loans

Qualifications for personal loans vary from lender to lender, and in most cases the factors that determine your eligibility for a personal loan include but are not limited to your credit score and  income. Approval for personal loans is usually fast–with some companies offering same-day approval. That said, even those with limited or less-than-perfect credit may still qualify for a loan–but there may be fewer lenders and less favorable options depending on how challenged your credit is.

Interest rates and repayment terms

Interest rates can vary among and between personal loans and equity loans. Generally speaking, the better your credit score, the more likely you’ll find a lender and more competitive terms.

Fixed rate

Both personal loans and equity loans tend to offer fixed interest rates, meaning the interest rates will not change over time. Fixed-rate loans also usually have fixed monthly payments, which means you’ll pay the same amount every month until the loan is paid off. These types of loans are good for borrowing larger amounts of money that you expect to pay off long-term.

Variable rate

There are some types of personal loans and equity loans that offer variable interest rates, which means the interest rates can fluctuate over time. The advantage of variable rate loans is usually that they have somewhat lower rates than comparable fixed-rate offerings at the same time. The tradeoff is that you bear the risk if rates rise while you’re repaying the variable-rate loan.

Risks

It almost goes without saying that everyone should make their loan payments on time, every time. But what happens if that becomes difficult for you, what happens if you miss a payment or find yourself in a situation where you may not be able to make one?

With equity loans and secured personal loans, missing payments could lead to foreclosure and losing your home or whatever is used as collateral for the secured personal loan.

With unsecured personal loans, missing payments often leads to a drop in credit score, and it can lead to legal action in some scenarios, meaning the creditor could sue you to obtain a judgment. Depending on your state, judgments may be enforced by garnishment of wages.

The best way to avoid these risks is to plan for the expenses of taking out a loan.

Bottom Line

Personal loans and home equity loans can both help you finance large expenses, and the right option for you ultimately depends on what’s going to fit in with your lifestyle. For many borrowers, that means having certainty in terms of how much they’re going to pay and for how long,

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