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Sometimes, borrowing money can be the key to meeting your personal or financial goals — as long as you do so responsibly.
Personal loans and home equity loans are two of the most popular financing options on the market. Both are installment loans that give you a lump sum upfront, to be paid back with interest through fixed monthly payments over a period of time. Both can be used for virtually anything, from home improvements to covering emergency expenses to consolidating other debts.
The key difference lies in each loan’s secured or unsecured nature and how that affects the rates and terms lenders offer.
Here’s everything you need to know about personal loans vs. home equity loans and how to choose the right option for your financial needs.
How Do Home Equity Loans Work?
With a home equity loan, you borrow against your home equity — your house’s current value minus what you owe on your mortgage. Home equity loans have fixed interest rates and repayment terms, meaning you’ll repay the loan in fixed installments over a period of five to 30 years.
Home equity loans are secured loans, which gives them certain advantages, says Danielle Miura, a certified financial planner (CFP) and owner of Spark Financials. “Because the home is used as collateral, it’s less risky for the bank,” she says. Because of this, home equity loans typically have lower interest rates than personal loans or credit cards.
Pro Tip
Whether you choose a personal loan or a home equity loan, be sure to compare rates and fees from multiple lenders to find the best deal.
How much you can borrow with a home equity loan depends on how much equity you have in your house. When evaluating your application, a lender will look at your combined loan-to-value ratio (CLTV), which is calculated by dividing all the total debts secured by your house (including your primary mortgage and any home equity loans or home equity lines of credit associated with your house) by your home’s appraised value. Most banks and credit unions will allow a maximum CLTV of 80% to 85%, meaning you need to keep at least 15% to 20% equity in your home.
For example, let’s say you own a $250,000 home and owe $150,000 on the mortgage. You have $100,000 in home equity, and your current CLTV is 60%. …….
Source: https://time.com/nextadvisor/loans/home-equity/personal-loan-vs-home-equity-loan/