Home Equity Loan or Personal Loan? What’s the best way to pay for a home improvement

While a new coat of paint can do wonders for a room, large scale improvements literally transform your home. New rooms, remodeled kitchens and bathrooms, or a finished basement not only create a more inviting and comfortable space, they add value to your home.

While a new coat of paint can do wonders for a room, large scale improvements literally transform your home. New rooms, remodeled kitchens and bathrooms, or a finished basement not only create a more inviting and comfortable space, they add value to your home. Who doesn’t want that? 

The question is, how to pay for such costly improvements?

If you are lucky enough to have lots of excess cash, this question is easily answered. If not, then you have a decision to make – personal loan, or home equity loan. 

Home Equity Loan

Like the name implies, a home equity loan is an amount of money borrowed against the equity in your home. This is a fixed-rate loan, repaid in monthly installments over a fixed period - usually around 15 years. A home equity loan is often referred to as a second mortgage. Most apply for this type of loan from their original mortgage lender, but you are certainly free to shop around from a variety of lenders. 

Personal Loan

Often call unsecured loans since no collateral is used, personal loans involve a sum of money repaid in equal installments over a fixed period of time. The interest rate on this type of loan is set by your credit score and history. Personal loans are available from traditional lenders, but there is a growing number of nontraditional lenders offering peer-to-peer loans. 

What’s the Difference?

Because you’re borrowing against your home, home equity loans usually offer lower interest rates and longer loan terms than personal loans. Also, the loan amount is limited only by the available equity in your home. The trade off is that the application process is very involved. You’ll have to pay for an appraisal on your home to determine equity, plus application fees are involved, just like with a traditional mortgage. This can sometimes take weeks. It’s also important to note that because you’ve put up your home as collateral, should you default on this loan, your lender can foreclose on you. 

Personal loans, because they are unsecured, usually involve smaller loan amounts and a larger monthly payment. The trade off is that the application process is much less stressful, plus you are not putting your home as collateral. 

Which is Right for You?

The answer is really up to you, and your circumstances. 

If you have a large amount of equity in your home, cash on hand to pay the fees, and are patient enough to deal with the application process, a home equity loan might be the right choice. It will generally yield a lower interest rate, longer loan terms, and lower monthly payments. 

However, if you don’t have a sizable amount of equity, not interested in another mortgage, or just need the money quicker, then a personal loan may be for you - especially if you have an excellent credit score. 

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