Personal Loan vs. Home Equity Loan

A home equity loan is a type of secured loan where the borrower puts up the equity (or percentage of ownership) in their home as collateral. Equity means the difference in your home's current, marketable value, versus the amount still owed on your mortgage. The loan is typically issued in a lump sum, has a fixed interest rate, with a long repayment term (generally between 10 to 30 years). It is sometimes referred to as a ‘second mortgage’ which is issued for reasons like: home renovations, debt consolidation, or a large expense.  

What is a Personal Loan?  

A personal loan is typically an unsecured loan, which means there is no collateral required for the loan. It is based upon your credit score, income, and ability to repay the loan. The loan amount is issued upfront at a lump sum amount, then the borrower repays the loan with monthly instalment amounts over a term of 1-7 years. Personal loans can be used for several different reasons ranging from: medical emergencies, education, weddings, travel, or household purchases. 

Features and Benefits of a Home Equity Loan 

Characteristics and Advantages of a Home Equity Loan are as follows:   

Features 

1. Secured by Property: A home equity loan is a secured loan, and your home is the collateral. So essentially the loan is secured by the equity you hold in the property. This is why lenders are more likely to make favorable loans with terms such as lower interest rates or higher loans amounts. 

1. Fixed Interest Rate: Most home equity loans have a fixed rate of interest, meaning the payment that you make each month stays the same for the term of the loan. Having predictable loan repayment is helpful for financial planning, especially when dealing with larger sums of money over longer periods of time. 

1. Long Repayment Term (10–30 years): Home equity loans offer long repayment terms; you can get a home equity loan between 10 years and 30 years. This gives borrowers the opportunity to lessen the burden of repayment while making larger monthly repayments workable. 

1. Higher Borrowing Limit (80–90% of Equity): The applicable borrowing limit depends on your total equity in your home. As a rule of thumb, lenders typically allow borrowing up to 80–90% of the appraised market value of your home, minus any outstanding mortgage balance. This makes a home equity loan a better option when larger sums are required. 

Benefits 

1. Lower Interest Rates than Unsecured Loans: This is usually a secured loan; therefore, the risk to the lender is less, and you typically pay far lower interest rates than you would with unsecured loans like personal loans or credit cards.  

1. Predictable Repayment Schedule: They have a fixed rate and loan repayment terms, so you know the exact amount you will be paying each month and when the loan will be paid off. This eliminates uncertainty and makes it easier to budget over the long term.  

1. Appropriate for Major Purchases: Home equity loans make sense for big financial needs such as home renovations or repairs, higher education, large medical expenses, or debt consolidation. The opportunity to access most expenses through a lump sum, at a low-interest rate, gives a lot of strength to big plans.  

1. Potential Tax Benefits: In some jurisdictions, including India in certain cases, the interest paid on a home equity loan may be tax-deductible if the loan proceeds are used for home-related improvements or construction. It’s a good idea to get clarification from a tax advisor. 

Features and Benefits of a Personal Loan 

The following are the features and advantages of a personal loan:  

Features 

1. No Collateral Required (Unsecured): This means that you do not have to pledge any type of asset, so personal loans are a good option if you have no property or do not want to risk any property. Loan approval is based on your income, credit score, and credit behavior.  

1. Variable or Fixed Interest Rate: Most personal loans have fixed-interest rates, but some lenders may offer variable interest rates. A fixed rate offers you consistency; however, a variable rate means that your interest rate is subject to changes according to the policies of the lending institution and/or market conditions.  

1. Short Time Frame (1 to 7 year repayment terms): Personal loans typically have shorter repayment terms ranging from 1 to 7 years (12 months to 84 months) approximately. This shorter term means a quicker payoff, however, it could result in higher monthly payments than longer term loans.  

1. Quick Disbursement (Usually 24-72 hours): Most personal loans involve little paperwork and are 100% digital, so they can be approved and disbursed quickly, occasionally on the same day. This makes them an excellent option for emergencies or time-sensitive funding needs. 

Benefits 

1. No Asset Risk: Since it is an unsecured loan, if you default, there are no assets on the line (i.e. your house, car, or savings). But you will have a bad credit history, and legal measures may be pursued to recover the money owed.  

1. Fast Approval Process: When compared to taking out a secured loan, there is a significantly less cumbersome application process to navigate to obtain a personal loan. There's more than a few online and NBFC platforms that provide an immediate eligibility check and money credited/disbursed to your account on the same day, making personal loans very accessible.  

1. Flexible Usage: Personal loans can be used for virtually any legal reason (i.e. medical bills, travel, education, weddings, business expenses, debt, etc.). Lenders typically don't restrict the reason for using the loan amount. 

Key Differences between Home Equity Loan and Personal Loan 

The table below outlines the key differences between home equity loan and personal loan:  

When to Choose a Home Equity Loan 

Home equity loans are a great option for many borrowers that own real estate and have built equity over the years.  Such loans are a great choice in certain situations such as:  

1. You are a homeowner with equity  

If you have paid off most of your home mortgage, or if the value of your property has gone up a lot over time, you probably have a substantial amount of equity in your property. In fact, lenders will often allow 80-90% of the equity, allowing for a large amount of funds.  

1. You need a large loan, for the long term  

Home equity loans work great for large financial obligations that allow a longer repayment period, such as college tuition, major home renovations, medical expenses, or consolidating a number of high-interest debts. The large loan amounts and long repayment make them manageable from a financial point of view.  

1. You have the time to go through the process  

The application for a home equity loan will include value on the property, document verification, and formal approval, all of which can take 2 to 6 weeks. If your financial obligation is planned and not urgent, it is worth it to wait for better loan conditions. 

1. You would like lower interest rates  

Because the loan is secured by your house, lenders usually offer much lower interest rates compared to other unsecured loans. This will save you a lot in interest costs, especially in the case of a larger loan maximum over many years.  

1. You would use the loan to renovate a home or consolidate debt  

As with any loan that you would use to improve or maintain your home, you may be eligible for tax benefits depending on the province in which you reside. In addition, if you are consolidating higher interest debt, you could save money and simplify your finances by combining it into one home equity loan. 

When to Choose a Personal Loan 

If you need access to cash urgently and wish to avoid putting your assets at risk, you may want to consider a personal loan. There are situations where it may make more sense to take out a personal loan over securing other types of loans: 

1. You need to get a loan quickly without using your property as collateral 

Personal loans require no collateral which makes them a great option if a borrower doesn't own or doesn't want to use their property as collateral and needs approval quickly. With some lenders you can approve and get the cash in a few days or in some cases, a matter of hours.  

1. You don't need an especially large loan  

Personal loans are typically used for moderate expense situations such as weddings, travel, small medical procedures, or purchasing electronics.  

1. You want to do minimal paperwork & obtain cash quickly 

There are digital lenders and NBFCs who provide simple online application forms with very little submissions. There are even some that provide loan approvals instantly or on the same day that you applied, and this is highly convenient for the situation where you need some cash to pay for something time sensitive. 

1. You are comfortable with higher interest rates. 

Personal loans have a higher interest rate as they are unsecured loans. If you can afford the higher EMIs and you prefer the speed and convenience over going with secured loans, the higher costs may not be a problem for you.  

1. You have limited equity in your home. 

If you have merely been paying on a home loan - but have not built enough equity - or the home is jointly owned and you cannot use it as collateral, taking out a personal loan is a more feasible option. 

Home Equity Loan – Step-by-Step Process 

Obtaining a home equity loan goes beyond the minutiae of a personal loan. The process is more elaborate and lengthier, since the lender will require a property appraisal and legal validation, since you are obtaining a secured loan.  

1. Fill out Application Form and Submit Documentation to Lender: The lender will have an application form to fill out, which will request personal information, property information, income, current debt and the amount of loan you are seeking. The documentation will usually consist of: Proof of identity and address, Proof of income (salary slips/ITR), Property papers (sale deed, title papers, previous loan paper if any)  

1. Property Appraisal by Valuer: The lender will allocate an appraiser or valuation engineer to inspect the property. The appraiser will evaluate the value of the property on the current market, and its structural and legal status. The amount you are able to borrow is heavily influenced by the appraisal of the property. 

1. Credit Evaluation and Income Verification: The lender will assess your credit report, which includes your CIBIL score, as well as all proof of income documentation. The lender needs to determine if your debt service capacity matches the loan amount you are requesting. Your personal credit score matters and as long as you have a score of 700+, will assist you with getting the loan approved, as well as getting favourable terms. 

1. Legal Examination of Property Titles: This next phase is dedicated to a legal team reviewing the title of ownership documentation submitted to the lender. If there are any disputed ownership, if there is an ongoing lawsuit on property title, or if there is any illegal building of the property the application could get rejected 

1. Loan Offer Issued: Upon completion of the above checks, the lender shall issue either a sanction letter or a loan offer. This will detail: the loan amount, the interest rate, the repayment term, an EMI schedule, and terms/conditions.  

1. Signing of the Agreement: If the offer is accepted, you will be required to sign an agreement for the loan which would include the signing of a promissory note, mortgage deed, and other related documentation where required.  

1. Loan Disbursed: Once the legal formalities are complete, the loan will be disbursed. This loan can either be credited to your account as a lumpsum or in tranches (for example, for home renovation, some lenders will issue funding in tranches as the work is completed). Usually, the time frame is 15-30 working days. However, this may change based on how readily documents are available, how complicated the property is, and the lender's efficiencies 

Personal Loan – Step-by-Step Process 

Personal loans are built for speed and convenience, particularly for salaried borrowers or those with strong credit scores.  

1. Apply Online or at Branch: You can apply for a personal loan via the lender's website, mobile app, or at a branch. Many fintech companies allow you to complete the loan application online and compare multiple offers from lenders. 

1. Provide Basic Documents: Very simple KYC and income documents are provided such as: PAN and Aadhaar, bank statements, salary slips, or ITR. Most lenders will now also accept e-KYC with Aadhaar based OTP verification via your smartphone that minimizes paperwork.   

1. Instant Credit Report and Assessment of Eligibility: The lender will pull your credit report instantly and assess eligibility from several parameters including credit score, monthly income, existing liabilities, and employment history. This may all be automated. 

1. Approval (Can be Same Day with Fintech/NBFCs): If all terms are met, the lender can approve within minutes or a couple of hours (Fintech/NBFC). Some platforms even offer pre-approved loans and can remove many of the steps altogether  

1. Loan Agreement Signed by E-Signature: Once approved, you will receive a loan agreement electronically. Through e-signature and Aadhaar verification and some platforms instant transfer of the loan funds, all without paper, not only safety but also speed. 

1. Disbursal of Loan: Once you have signed, the funds will be directed into your bank account, usually within the same day for smaller amounts or if you're working with NBFCs/ fintech lenders. Most of the time, it will be done between 24 - 48 hours, if you provide all content after applying, and have good credit. 

A good credit score can help you secure lower interest rates on loans and credit cards.

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