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

Ailsa Adam April 23, 2024

A home loan lets you borrow cash. The amount? It depends on your home’s worth. Pretty cool, right? You get money now. But you must pay it back later, with interest.

A personal loan is money borrowed, too, but it’s not tied to your home’s value. Instead, the lender looks at things like your job and credit score. Again, you must repay the loan with interest added on top.

Taking the wrong loan can lead to issues. You may pay more interest than needed. Or maybe the loan doesn’t fit your situation well. That’s why it’s smart to understand loan types and choose carefully.

It’s essential to pick the best loan for your needs. The wrong choice can lead to major headaches and money struggles, so it pays to understand why making this decision right matters so much.

What is a Home Equity Loan?

A home equity loan is a way to get money. You use the value in your home as a backup, which is called equity. The loan lets you tap into that equity. You get a sum of cash upfront to use.

How it Works: Using Home Equity as Collateral?

Your home acts as security for the loan, which is called collateral. If the loan terms are not fulfilled, the lender can take ownership of the house. The more you own, the more you can borrow. Equity increases with the appreciation of your property over time.

Common Uses for

These loans are handy for big costs like:

  • Home repairs or renovations
  • Paying for school or college
  • Consolidating other costly debts
  • Funding a business start-up

They offer lower rates than other loan types. This makes them appealing for:

  • Large expenses over time
  • Investments that build wealth
  • Debt consolidation savings

Debt consolidation was the main reason people took out personal loans last year, accounting for almost 40% of all loan originations. Many borrowed these loans to set up a fixed monthly payment that included other pricier debts, such as credit cards.

What is a Personal Loan?

A personal loan is money you borrow from a lender. You get a lump sum upfront, and you agree to pay it back over time. These loans don’t need collateral like a home. The lender trusts you to repay based on your income.

How does it work?

Since personal loans do not have collateral, they are “unsecured.” The terms are fixed from the start, including the loan amount, interest rate, and repayment schedule. You make equal monthly payments until the loan is paid off.

In 2023, gross personal loan lending in the UK grew by 13%, reaching £42.1 billion.

Common Uses for Personal Loans

People use personal loans for many one-time needs:

  • Consolidating high-interest debt
  • Financing a wedding or vacation
  • Paying for home repairs or medical bills
  • Buying a car or making a large purchase

They offer fast, flexible financing when you need it most. The funds can cover:

  • Unexpected emergencies or costs
  • Moving or relocation expenses
  • Starting a business or investment

Key advantages include:

  • No collateral required
  • Fixed, predictable payments
  • Quick funding process

About 23% of residents in the capital had a personal loan last year. As for the age breakdown, the 35-44-year-old crowd took out around 22% of new personal loans originated.

Interest Rates

Equity loans tend to have lower interest rates. This is because you put up your home as collateral. Personal loans are unsecured. So, their rates are usually higher to offset the extra risk for lenders.

For those taking out personal loans on benefits from a direct lender, interest rates can be higher compared to mainstream lenders. Direct lenders may view benefit income as riskier, leading to rates often ranging from 20% to 49.9% APR.

However, they can provide easier access to credit for those unable to qualify elsewhere. While costly, these loans offer a borrowing option for benefit recipients with poor or limited credit histories.

Factors Affecting Interest Rates

For home equity loans, rates depend mainly on:

  • Your credit score
  • Income and home equity
  • Current market rates

With personal loans, common factors are:

  • Credit history and income
  • Debt-to-income ratio
  • Loan amount and term

Typical Rate Ranges:

Loan TypeAverage Rate Range
Home Equity Loan3% – 8%
Personal Loan (Good Credit)6% – 18%
Personal Loan (Fair Credit)18% – 36%

The rates shown are for illustrative purposes only. Your current rate will largely depend on your financial situation when you apply.

In addition to the above, factors such as employment status, credit score, and lender policy determine the interest rate a person will be offered. Typically, the rendering of your credit profile is the major determinant of the monthly payment rate.

Lenders will not use your credit score but your debt ratio to calculate the risk. But remember to shop around, as rates can vary significantly between lenders.

Loan Amounts and Terms

Home equity loans let you borrow bigger sums. The maximum is based on your home’s value and equity. Many lenders cap them at 85% of your home equity. So, a home worth £300,000 with £100,000 in equity could get up to £85,000.

Personal loan amounts are smaller, say £3,000 to £100,000. They depend on your income and ability to repay. Looking for something like a 3000-pound loan? Personal loans cover lower amounts.

Typical Repayment Terms

Home equity loans tend to have longer repayment periods:

  • 5 to 30 years is common
  • Payments are lower due to longer terms
  • Allows time to repay the larger balances

For personal loans, the typical term range is:

  • 1 to 7 years
  • Most are 3-5 years
  • Shorter terms mean higher monthly payments
Loan TypeTypical Amount RangeCommon Term Length
Home Equity Loan£25,000 – £350,0005 – 30 years
Personal Loan£3,000 – £100,0001 – 7 years

The right term depends on:

  • The loan purpose
  • How much you can afford monthly
  • Your preference for cost versus duration

So, consider your needs, budget, and pay-off goals carefully. The term impacts your total interest paid over the life of the loan.

Access to Funds

When you need cash quickly, personal loans are the faster option. You can often get the funds within a week or two after approval. The process is straightforward for most lenders.

Home equity loans take a bit more time – usually 2 to 6 weeks. That’s because extra steps like a home appraisal are required. The property value has to be verified before finalising the loan.

So, if speed is crucial, personal loans have the edge for rapid access to funds. But home equity may be worth the wait if you qualify for a larger amount.

Process and Documentation Required

ComponentPersonal LoanHome Equity Loan
Typical Documentation RequiredProof of income (pay stubs, tax returns) Bank statements Credit report Photo ID Loan applicationHome appraisal report Mortgage statements Property tax records Homeowners Insurance Income/asset verification Home inspection report (sometimes Home equity application Preliminary title search
Funds Access Timeframe1-2 weeks2-6 weeks

The process is more complex but worth it for lower rates if you have enough home equity built up. Prepare for more paperwork.

Tax Implications

Another great thing about a home equity loan is that the interest payment may qualify for a tax deduction. Thus, the IRS lets you deduct mortgage interest paid on loans used for building, buying, or extensively improving your home. So, instead of paying closing costs, if you use that home equity cash for renovations or repairs, you will be able to write off the interest come tax time.

But there’s a limit – only interest on loans up to £750,000 in total mortgage debt qualifies. And the interest has to be for your main home, not a vacation crib. Still, every little deduction helps during tax season!

Now, personal loan interest generally is not tax deductible. The exception is if you use the funds for certain qualified expenses like higher education costs. In that case, the interest may be eligible for a deduction.

Otherwise, personal loan interest doesn’t give you any tax advantages. The loan doesn’t get special tax treatment like a mortgage. You’re just borrowing money and paying it back with after-tax.

The rules can get complicated fast, though. Make sure you understand what qualifies before claiming any interest deductions. No one wants an unexpected tax bill from the IRS! Your tax pro can advise based on your specific situation.


Then, there are the requirements and qualifications for approval. You don’t want to apply for a loan you can’t even get! That can hurt your credit score unnecessarily. Nor do you want a loan with conditions you can’t realistically meet long-term.

Some loans also require security or collateral, like your home’s value, for a home equity loan. If you can’t repay, you could lose that asset. The same goes for auto loans secured by your vehicle’s title. There is a huge risk if you pick wrong!

Using debt for the wrong reasons can backfire, too. Taking a personal loan to pay off credit cards is fine. But using it for a vacation or splurge purchase? That’s just asking for trouble repaying down the road.

The application process can be a headache as well if you choose poorly. Some lenders ask for tons of paperwork and documentation. Others have frustrating automated processes with no human help available. At the end of the day, the right loan makes life easier all around. Proper timing, rates, and terms help your budget rather than strain it. You avoid late fees and debt traps, too. Who wouldn’t want that peace of mind?

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