Borrowers often confuse to distinguish clearly between the different types of home equity loans and personal loans.
When we talk about a home equity loan, it can either be a term loan or a line of credit, often referred to as HELOC. A personal loan can also exist in either of the two forms, with the latter being known as a personal line of credit.
What is a home equity loan or line of credit?
While a home equity loan or line is almost always a kind of secured loan, a personal loan can be either secured or unsecured, depending on the need of collateral.
A secured personal loan, such as an auto loan, is more like a home equity loan, since the borrower always runs the risk of losing collateral in case of a default.
1. Approval Time
A home equity loan is usually referred to as a second mortgage. Similar to a mortgage loan, it would require a lot of things to get approved, such as your credit score, equity value and LTV. You are likely to wait a few days for the approval decision to come out.
On the contrary, you are likely to be approved within two hours or so when you apply for a personal loan. This is because the financing institution has to look into only a few details of the applicants, such as the monthly income and the credit score.
Most personal loan lenders claim to credit the fund within a day or two upon approval. This is not the case with a home equity loan or line as the lender must look at the property appraisal report before taking a final decision.
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The borrowers also need to pay some upfront fees, such as an appraisal fee and a closing fee, for a home equity product. If you need the loan for debt consolidation, an early pay-off fee must also be taken into consideration.
Though a personal loan may not have a fee, a personal line of credit might have one. For example, Wells Fargo usually charges an annual fee of $25 for a personal line of credit.
APRs and interest rates can be much lower in case of a home equity loan. This is what makes it a preferable choice for many borrowers.
The typical interest rate on a home equity loan may range from 4-6% while the same on a personal loan can usually be more than 8%. This is just the double, and that’s too when you really possess a very good credit score.
4. Borrowing Limit
An important criterion to choose between a home equity loan and an unsecured personal loan is the money you want to borrow. For small amounts, an unsecured loan is usually preferable.
Not many lenders would be willing to offer a very high sum if it is not backed by suitable collateral. An exception is Wells Fargo, which can lend up to $100,000 in personal financing.
Most personal loan lenders offer a sum up to $25,000. So, if you need to borrow more than that, a home equity loan would be an obvious choice provided you qualify for that.
5. Repayment Term
Like a mortgage loan, a home equity loan can be rolled into a term of up to 30 years. This is useful if you need to borrow a big amount and want a flexible repayment option.
A personal loan or line of credit, on the other hand, usually comes with a term of up to 5 years. The best thing is that you know exactly how much you need to pay every month to amortize in a finite term.
6. Credit Requirement
A personal loan approval is primarily based on your credit score and monthly paycheck. The more your score is, the greater will be your chances of approval, and the less you will pay in interest as well.
According to a study, a borrower with a poor credit score (580-619) usually needs to pay an interest rate of 30% or more whereas a borrower with an excellent credit score (740-850) needs to pay well below 10% in interest.
A home equity loan, on the other hand, has a much complicated underwriting process that may look into the details of borrower’s income, real estate appraisal, credit history, and equity value.
The interest payments on an unsecured personal loan are not tax deductible. However, a secured personal loan may qualify for tax deduction under certain circumstances.
Borrowers with a home equity loan will always enjoy the tax benefits as they do with a typical mortgage loan.
Now that you know the 7 important differences, you will find it easy to choose between a home equity loan and a personal loan for your financial need.