Explore the similarities and differences of personal loans and home equity loans, as well as alternatives, to find the most suitable option for you.

  • Personal loans allow borrowers to access a lump sum of money without collateral.
  • Home equity loans allow homeowners to borrow a lump sum against their home equity, using the home as collateral to secure the loan. 
  • Personal loans often provide faster funding with a simpler application process, while home equity loans tend to offer higher loan limits, lower interest rates, and longer repayment periods.

Major expenses are an inevitable part of life. They may be planned (such as tackling a home renovation project or expanding your family through adoption or fertility treatments). But they can also be unexpected (as is often the case with emergency costs like car repairs or medical expenses). 

Personal loans provide a solution for qualified applicants seeking to borrow money for large expenses. However, if you own a home, you may also have access to a home equity loan. 

In this article, we’ll explore both options. You’ll learn:

  • What a personal loan is and how it works
  • What a home equity loan is and how it works
  • How to decide which option may be the better fit for you
  • Alternatives that may serve certain borrowers better than a personal loan or home equity loan.

What Is a Personal Loan?

A personal loan allows you to borrow a lump sum of money that is repaid in monthly installments with a fixed interest rate over a set period of time.

Most personal loans are unsecured, meaning that they do not require you to use your property as collateral. However, some lenders also offer secured personal loans, which are backed by assets such as a vehicle, stocks, or a savings account.[1] 

Personal loans typically offer a fixed interest rate, so the rate does not change over the term of the loan. This means your monthly installment payments remain set at the same, predictable amount month after month.   

How Does a Personal Loan Work?

Personal loans may be used for a wide range of purposes, including debt consolidation, home improvements, medical expenses, moving costs, weddings, or other major purchases.

Here’s how personal loans work:

  1. You apply for a set amount of money. The amount you are approved for typically depends on factors like your credit score, income level, and current debt obligations.[2]
  2. The lender reviews your application to determine whether you qualify (and what interest rate and term you may be eligible for).
  3. If the borrower agrees to the loan terms and signs the loan closing documents, the loan becomes a legally binding contract.
  4. The lender then disburses the funds in a lump sum, usually within 1-3 business days. 
  5. Repayment begins immediately, with the first payment typically due within 30-60 days. Each payment typically covers both principal and interest (although the percentage of the payment allocated to each category may shift over the term, with early payments allocating more to interest, and later payments allocating more to principal).     

Pros and Cons of Personal Loans

While the specific terms of any loan may vary by lender, economic conditions, and the applicant’s financial profile, personal loans generally have certain advantages and disadvantages compared to home equity loans.

Benefits of a personal loan include:

  • No home equity required (even renters may qualify for a personal loan)
  • In most cases, no collateral of any kind is required
  • Relatively quick application processes and loan funding timelines

Potential drawbacks of personal loans include:

  • Higher interest rates on average (particularly in the case of unsecured loans, which present a greater risk to the lender)
  • Lower maximum loan amounts
  • Shorter repayment periods
  • No potential for any income tax benefit 

What Is a Home Equity Loan?

A home equity loan is a lump-sum amount that qualified homeowners borrow against the equity in their homes.[3] Equity is the value of your home minus any debts against the home (like a mortgage, for example).[3] While you can’t typically access the full value of your equity, many lenders allow you to borrow as much as 70-80% of the combined loan-to-value (CLTV). 

For example, if your home is worth $600,000, and you have a mortgage balance of $400,000, you have $200,000 in home equity. If your lender allows you to borrow 75% of your CLTV (based on factors like credit scores, debt-to-income ratios (DTIs), and general lender policies), you could potentially borrow as much as $50,000 via a home equity loan.   

Home equity loans are, by definition, secured, using the home as collateral for the loan. Failure to repay the loan could potentially result in foreclosure of the mortgage, meaning that the lender could seize ownership of the property if the borrower defaults.[4]

Like personal loans, home equity loans typically offer a fixed interest rate, allowing your monthly installment payments to remain steady throughout the loan term. 

How Does a Home Equity Loan Work?

Home equity loans may generally be used for the same purposes as personal loans, including debt consolidation, home improvements, medical expenses, and large purchases. 

Here’s how home equity loans work:

  1. You apply for a set amount of money. The maximum loan amount often depends on factors like how much equity you have in the home, how much of that equity lenders are willing to loan against, your credit scores, income, and existing debts.
  2. The lender reviews your application to determine if you qualify (and what interest rate and terms they may offer). Importantly, this review process typically requires an appraisal of the property to determine its current value as well.  
  3. If both parties agree to move forward, loan documents are drafted and signed, creating a binding legal contract.
  4. The lender provides the funds in a lump sum. 
  5. As with personal loans, repayment on home equity loans begins immediately, with the first installment typically due within 30-60 days, and each payment covers a share of both principal and interest.       

Pros and Cons of Home Equity Loans

Potential benefits of home equity loans include:

  • Lower interest rates on average (since the loan is backed by the home, providing greater security for the lender)
  • Higher maximum loan amounts
  • Longer repayment periods
  • Interest may be tax-deductible when the funds are used for qualifying home improvements (please discuss your unique situation with a qualified tax accountant)

Possible drawbacks of home equity loans include:

  • The property must meet the lender’s equity requirements to qualify
  • A longer, more detailed application process
  • In the event of default, the home may be at risk of foreclosure
  Personal Loan Home Equity Loan
Collateral requirements Often unsecured, meaning no collateral is necessary Secured, using your home as collateral
Loan amounts Generally smaller loan amounts Often allows larger loan amounts, based on available home equity
Interest rates Often higher because the loan is unsecured Often lower because the loan is backed by your home
Repayment terms Typically 2-7 years, though some lenders offer longer terms Often 5-30 years
Speed of funding Usually faster; funds may be available within days Typically slower due to underwriting, appraisal, and closing requirements
Fees May include origination fees and other lender charges May include appraisal fees, origination fees, closing costs, and other lender charges
Risks Default can damage your credit and potentially result in the seizure of any collateral (if loan is secured by collateral) Default can damage your credit and potentially result in the foreclosure of your house
Tax implications Interest is generally not tax-deductible for personal expenses Interest may be tax-deductible in some cases when funds are used for qualifying home improvements

When to Choose a Personal Loan

A personal loan may be preferable to a home equity loan if:

  • You don’t own real estate or don’t have enough home equity to qualify for a home equity loan
  • You need a comparatively small amount of money
  • Time is of the essence
  • You are unwilling to use your home as collateral (perhaps due to risk aversion)

When to Choose a Home Equity Loan

Scenarios where a home equity loan is preferable (e.g., large expenses, lower rates, longer repayment, sufficient equity).

A home equity loan may be a more preferable solution if:

  • You have sufficient equity to qualify
  • You are looking for the lower interest rate option
  • You need a comparatively large amount of money
  • A longer repayment period is suitable
  • You have the time to complete the home equity loan application process, including getting the home appraised

3 Alternatives to Personal and Home Equity Loans

1. Home Equity Line of Credit (HELOC)

A HELOC is a revolving credit line, backed by your home equity. Unlike home equity loans and personal loans, HELOCs allow you to borrow incrementally, rather than access a lump sum.[5] This may be helpful in situations where the total amount needed isn’t known upfront (as is often the case with home renovations, for example).

There are two phases to a HELOC: the draw period and the repayment period. During the draw period (often three to 10 years), you may borrow against the credit line as needed, up to the maximum amount, with comparatively low monthly payments. During the repayment period (often five to 30 years), the full amount is repaid with interest. 

When considering a HELOC vs. a personal loan, remember that HELOCs are secured by the home, so failure to repay might result in foreclosure, whereas failure to repay a personal loan typically does not risk loss of the home.

2. Cash-Out Refinancing

A cash-out refinance replaces your existing mortgage with a new, higher-balance mortgage, under new terms, including a new interest rate.[6] The new mortgage in the larger amount effectively pays off the existing mortgage, with money left over to provide you with funds. 

Because this restructures your entire mortgage, a cash-out refinance typically only makes financial sense if the new interest rate would be lower than the rate on your existing mortgage. As with all mortgages, the cash-out refinance would be secured by the property.

3. Credit Cards

Credit cards are unsecured revolving credit lines. You may borrow as needed, up to the credit limit, make monthly payments to reduce the balance, and borrow again. Credit cards typically renew in perpetuity, so you may continue to charge expenses to the card and repay the charges for years, or even decades. 

Credit cards typically come with high interest rates, and easy access to funds may make it difficult to stop spending. Credit cards may be useful in an emergency, but are generally not a sound long-term financial solution.

How to Decide Between a Personal Loan and a Home Equity Loan

When deciding between financing options, start by considering your needs and goals. How much do you need? How will using the funds affect your life, financially and practically? 

Then consider your ability to qualify for each loan type. Do you have enough home equity to borrow against? Is your current credit score and DTI sufficient to earn terms you’re comfortable with?

And finally, factor in the application process, repayment timelines, and your personal risk tolerance when choosing the option that best suits you. 

When in doubt, you may seek the guidance of a financial advisor or consult with a lender for insights on available borrowing options. Home Lending Center representatives from PNC Bank can also be reached by phone at 1-855-762-9545. 

Once you understand your options, you’ll be prepared to tackle life’s major expenses whenever and however they may arise.