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Non-housing debt in America hit a staggering $4.87 trillion in Q1 2024. You're certainly not alone if you're carrying debt, but how you manage it makes all the difference.
Two choices are worth comparing to pay down your debt: home equity vs personal loans.
While both might be used for debt consolidation, key differences may make one option more suitable for each person’s particular needs.
In this article, we will compare home equity and personal loans and help you discover which is best for your personal situation in paying off debt.
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Understanding the basics of your loan options
Before discussing the comparison, it’s essential to understand the differences between home equity and personal loans and how they work.
Home Equity Loan
Home Equity Loans enable you to borrow against the equity you've built up in your property, which is secured by the property itself.
The loan amount would be based on the difference between your home's current market value and the outstanding mortgage balance.
Home Equity Loans typically offer:
- Fixed interest rates
- Monthly installments
- Set prepayment periods, usually ranging from 5 to 20 years
Personal loan
A personal loan is an unsecured loan—it does not require collateral. The loan amount is based on your creditworthiness and income.
Personal loans can be used for various purposes, including debt consolidation.
Personal loans usually have fixed interest rates and monthly payments. The repayment period can vary but typically ranges from 2 to 7 years.
Home Equity Loans for debt consolidation and repayment
While personal loans can be a debt consolidation option, Home Equity Loans offer a more strategic approach with potentially lower interest rates.
Lower interest rates
One of the most significant advantages of a Home Equity Loan over a personal loan is the interest rate.
Home Equity Loans generally feature lower interest rates because they are secured by significant collateral.
This security reduces the lender’s risk, allowing them to offer more favorable rates. In contrast, personal loans—being unsecured—tend to have higher interest rates due to the increased risk for lenders.
Higher borrowing limits
Home Equity Loans typically allow for higher borrowing limits compared to personal loans.
Since the loan amount is based on the value of your home, you can potentially access a larger sum of money.
This can be particularly beneficial if you have substantial debt to consolidate.
Conversely, personal loans often result in lower borrowing limits because they are only based on credit scores and income.
Tax deductibility
In some cases, interest paid on Home Equity Loans might be considered tax-deductible, provided the loan was used for home improvements1.
While this tax benefit is not available for debt consolidation, it’s an added advantage if you plan to use part of the loan for eligible home improvement projects.
Personal loans do not offer this potential tax benefit.
Fixed interest rates and payments
Home Equity Loans can provide greater stability and predictability for budgeting because of their fixed interest rates and fixed monthly payments, which are common features of these loans.
These can be significant advantages when consolidating debt, as you can plan your finances without worrying about fluctuating interest rates.
While many personal loans also offer fixed rates and payments, the rates are usually higher, making Home Equity Loans more cost-effective in the long run.
Comparing Home Equity Loans vs personal loans
Collateral
The collateral is the big difference when comparing home equity vs personal loans.
Home Equity Loans are secured by your home, meaning that if you default on the loan, the lender can foreclose on your property.
Personal loans are unsecured, so no collateral is required. However, you’ll have to balance that missing security against the higher interest rates and lower borrowing limits of personal loans.
Loan approval
Approval for a Home Equity Loan is primarily based on the equity you have in your home and your credit history and income.
The application process may also involve an appraisal of your home to help figure out its current market value.
On the other hand, personal loans are approved based on your creditworthiness, income, and debt-to-income ratio without needing an appraisal.
Terms
The terms of a Home Equity Loan are typically longer, ranging from 5 to 20 years, while personal loans usually have shorter terms of 2 to 7 years.
Longer terms can mean lower monthly payments for Home Equity Loans, making them more manageable for debt consolidation.
Considerations before choosing a Home Equity Loan
While Home Equity Loans offer several advantages, there are also some considerations to keep in mind:
Risk of foreclosure
Like your mortgage payments, failing to repay a Home Equity Loan can result in foreclosure.
So ensure that you can comfortably afford the monthly payments and that consolidating your debt with a Home Equity Loan will benefit your financial situation.
Closing costs and fees
Home Equity Loans often have closing costs and fees similar to those associated with a mortgage. These can include appraisal fees, origination fees, and other expenses. Factor these costs into your decision-making process. However, MIDFLORIDA is currently offering a "No Closing Costs" promotion for eligible loans under $400,000 on primary residences, which can significantly reduce your upfront expenses.2
Long-term commitment
Home Equity Loans are long-term commitments, typically lasting 5 to 20 years.
Consider whether you’re prepared for this financial obligation over the long term and plan to manage your debt effectively during this period.
Home Equity Loan vs personal loan: Which is better to pay off debt?
By weighing the benefits and considerations of Home Equity Loans and personal loans, you can decide which option is best for paying off your debt.
With the potential for lower interest rates, higher borrowing limits, and fixed payments, a Home Equity Loan might be the right choice to help you achieve financial stability.
Start your application with MIDFLORIDA
If you’re considering a Home Equity Loan to pay off debt, MIDFLORIDA can help.
With competitive interest rates, flexible terms, and personalized service, we can guide you through the process and recommend the best financial decision for your needs.
Start your application with MIDFLORIDA and take the first step toward achieving your financial goals.
Content accurate as of September 1, 2024.
