Whether you’ve just moved into a new house or you’re spiffing up a long-term place, home improvements are not cheap.
The average kitchen remodel, for example, cost $19,993 in 2016, according to HomeAdvisor.com. Other parts of the home (like a bathroom or garage) cost about half that, but these expenses can add up—particularly if you’re remodeling an entire house.
Many homeowners overcome this challenge with a loan to cover remodeling costs—but how do you know whether a home equity loan or a home improvement personal loan is better for your situation? We’re here to help.
Isn’t a loan… a loan?
At its most basic, yes. But there are nuances that distinguish the two types of loans.
A home equity loan leverages the money you’ve already paid towards your house—your home equity—as a guarantee to the lender that you’ll repay the loan. This is a type of secured loan, in this case secured by your house, which the lender can seize should you fail to make your payments. Homeowners can typically borrow up to 85% of their equity, and the loan is made for a fixed amount of money, all at once.
Home equity loan terms tend to be around 15 years, but can range from five to 30 years. Rates for these loans currently hover around 5%, the average being 5.21% in early 2017. A home equity loan has similar interests rates as but is distinct from a home equity line of credit (commonly known as HELOC), which acts as a revolving line of credit rather than a one-time installment.
A home improvement personal loan, on the other hand, is an unsecured loan, so the lender takes on additional risk. As such, personal loan rates tend to be higher than those for home equity loans— Earnest offers home improvement personal loans starting at 5.25%.
These loans are personal loans applied toward home improvements, and repayment terms are therefore shorter—generally a few years at the most. If you don’t make your payments on a personal loan, the lender can send your account to collections (which damages your credit), but does not have the right seize your house or other assets.
However, both a home equity loan and a home improvement personal loan function similarly once you’re approved—you’ll make monthly payments to the lender, interest will accrue as time passes, and the rate you’re given when you apply stays the same, as they’re both fixed-rate loans.
When a Personal Loan Makes More Sense
There are a number of factors that can make a personal loan a better option than a home equity loan.
Speed and ease of securing your loan
First, personal loans are generally easier and faster to get. Applying for a home equity loan requires a lot of paperwork as it’s similar to a mortgage—in fact, you’d better start gathering your past two years of financial documents if a home equity loan is your first choice.
Most personal loans, on the other hand, will require only basic documentation to verify your identity and income. In addition, personal loan applicants typically receive a loan decision within days, as opposed to weeks. For borrowers on a tight timeline, such as this couple who had already signed a contractor and needed the funds immediately, a personal loan can be the perfect solution.
Amount of equity you have in your home
Second, for those who bought a house recently, a personal loan may be your only option. As the name suggests, a home equity loan requires you to have equity in your home—which you won’t have until you’ve been paying your mortgage for some time. In pre-financial crisis days, home equity loans were given out readily, but it doesn’t look like these practices will be coming back any time soon—80% of home equity lenders did not report any changes in their underwriting criteria in 2016, meaning your chances of qualifying for one of these loans without having paid a significant chunk of your mortgage are slim.
Planning to use your home equity for another expense?
Lastly, a personal loan might be a better choice if you were planning to tap your home equity for something else. Some families rely on their home equity to help pay for college education, while others might use a home equity loan to start a business or cover other liabilities. If this is the case, a personal loan could allow you to both make the necessary home improvements and leverage your home equity for another purpose.
When a Home Equity Loan Makes More Sense
Personal loans can be a good option for home improvements that will require between $25,000 and $60,000, as lenders typically won’t give you much more than that for an unsecured personal loan. If you’ve paid off a good amount of your mortgage, however, you may be able to get a home equity loan for a higher amount.
In addition, secured loans tend to come with lower interest rates, and home equity loans typically hold a longer loan term than do personal loans—translating to lower monthly payments. If you have significant equity in your home as well as the time and patience to wait for your application to be approved and the money delivered, a home equity loan may be a less expensive option in the long run.
As with any loan, it’s always worth shopping around to compare your options—and in this case, it might be worth comparing not only within, but also across, loan types.