Is It Better to Take Out a Personal Loan or Use Home Equity for a Large Expense?
When a major expense comes up, many people turn to the convenient financing option offered by the seller or service provider, whether it is a car loan, in-store financing, a credit card promotion, or home service financing. If you are a homeowner, there is another financing option that might be available: the equity in your home.
Home equity can often be accessed through a home equity loan or a home equity line of credit (HELOC) and used for almost any type of expense. As with all loan types, there are some risks when you borrow against your home equity, but it also offers meaningful advantages compared to an unsecured personal loan.
How Personal Loans Typically Work for Large Expenses
Personal loans are unsecured, meaning they are not tied to an asset like a home. They usually come with a fixed interest rate, a fixed repayment term, and a predictable monthly payment.
This structure makes personal loans straightforward. Once the loan is funded, the balance and payment schedule are set. Borrowers know exactly how long repayment will last and when the loan will be paid off.
The main tradeoff is cost. Because personal loans are unsecured, interest rates are often higher than home equity options, particularly for larger balances or longer terms. For some borrowers, that higher rate is an acceptable tradeoff for keeping their home out of the equation.
How Home Equity Loans and HELOCs Compare
Home equity loans and HELOCs are secured by the borrower’s home, which usually allows for lower interest rates than unsecured loans.
A home equity loan works much like a traditional installment loan. The borrower receives a lump sum and repays it at a fixed interest rate over a set term, with the same monthly payment each month. At Ouachita Valley Federal Credit Union, home equity loans are available for amounts up to $200,000, with fixed-rate terms ranging from 1 to 15 years. This option offers payment stability while still taking advantage of lower rates that come with using home equity.
A home equity line of credit (HELOC) provides access to a revolving line of credit that can be used as needed. Ouachita Valley FCU’s HELOCs offer a five-year draw period and a variable interest rate, with borrowing available up to $200,000.
Monthly HELOC payments are based on the balance owed, calculated as either 1 percent of the balance or $100, whichever is greater.
Because both options are tied to the borrower’s home, the loan amounts available are often larger than is available with a personal loan. This can make home equity loans suitable for significant expenses or consolidating higher-rate debt, like credit card debt.
Key Differences That Matter When Comparing the Two
Cost is one of the most noticeable differences. Home equity options usually carry lower interest rates, which can reduce the total cost of borrowing over time. Personal loans tend to have higher interest rates but often offer a faster application process, since they do not require an appraisal or collateral.
Risk is another important distinction. Personal loans do not use the home as collateral, so there’s no risk of foreclosure if you fail to pay back the loan.
Cash flow can differ as well. Personal loans and home equity loans have a fixed payment from start to finish. HELOCs offer more payment flexibility early on, while home equity loans provide long-term consistency.
The different repayment timelines might also influence your decision. The revolving nature of a HELOC gives borrowers extra repayment flexibility, which might be more appealing for some financing needs than a fixed home equity loan or personal loan.
When a Personal Loan May Make More Sense
A personal loan may be the better fit when the expense is smaller or clearly one-time. It can also be appealing for borrowers who want a defined payoff date and prefer not to tie the expense to their home.
For those who value simplicity and predictable payments over the lowest possible interest rate, a personal loan may look like the better option.
When Home Equity May Be the Better Option
Using home equity often makes sense when the expense is larger and will take many years to pay off. A personal loan with a higher interest rate could become much more expensive than a home equity loan.
If you’re renovating your home or suspect you’ll need to pay for multiple expensive projects in a row, like a roof replacement, HVAC replacement, new flooring, and a bathroom remodel, a HELOC may make the most sense. Instead of taking out a loan for each project or putting those big-ticket purchases on a high-interest credit card, you can use one HELOC.
Consider Your Financing Options Before Taking Out a Loan
The loan that works best for you and your purchase will depend on the situation. Comparing interest rates, payments, total cost, and repayment timelines side by side can help you decide which option will be best.
Members of Ouachita Valley Federal Credit Union have access to all these loan options. From personal loans and credit cards to HELOCs and home equity loans, we can explain your options and help you weigh the pros and cons of each before you decide.
Speak with one of our lending professionals by calling 318.387.4592.
