Are Personal Loans Safer Than Home Equity Loans?

You may want to favor a personal loan for one big reason.

There may come a point when you need to borrow money, whether it's to pay off some bills or renovate your living space. If you're a homeowner, you have a few options. You could borrow against your property with a home equity loan, or you could opt for a personal loan. You may want to go with the latter for one important reason.

Secured vs. unsecured loans

There are certain types of loans that are secured by specific assets or collateral. A mortgage, for example, is secured by the home you're borrowing money to finance. An auto loan, meanwhile, is secured by the vehicle it's used to help buy.

Home equity loans are considered secured loans, and the asset they're tied to is your home itself. If you take out a home equity loan and you don't keep up with your payments, your lender could, in an extreme situation, force the sale of your home to get repaid what it's owed.

Personal loans, meanwhile, are unsecured loans. With a personal loan, you're not tying the sum you borrow to a specific asset, which means if you fall behind on your loan payments, your lender may not have a way to get repaid easily.

It's for this reason you may want to favor a personal loan over a home equity loan for borrowing purposes. You might pay more interest on a personal loan than on a home equity loan because your lender is taking more of a risk. But in exchange, you won't be putting your home on the line.

To be clear, there are consequences involved when you fall behind on any loan you take out. Failing to make your payments could cause serious damage to your credit score, which could, in turn, make it extremely difficult to borrow the next time you need to. But if you're worried about the idea of potentially losing your home due to not being able to repay a loan, then you may want to opt for a personal loan.

Are home equity loans easier to qualify for?

You may feel more comfortable taking out a personal loan over a home equity loan. But one thing you should know is that a home equity loan may be easier to get approved for, since it's based on the equity you have.

Home equity is calculated by taking the difference between your home's market value and your mortgage balance. If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 of equity. Once a lender sees that, it's apt to feel reasonably comfortable loaning you money.

With a personal loan, a lender is basing its decision largely on your credit score. And if your score isn't great, you might struggle to get approved for a personal loan, or get approved for a favorable rate. Of course, home equity lenders take credit scores into account, too. But they carry more weight with personal loans.

What's the right call?

Borrowing via a home equity loan could be a bit less expensive than taking out a personal loan. But if you're worried about your home serving as collateral for a loan, then a personal loan may be a better option for you.