Are Personal Loans Less Risky Than Home Equity Loans?

You may want to consider borrowing money via a personal loan — even if you own a home.

You may want to consider borrowing money via a personal loan — even if you own a home.

In the course of your life, you may need to borrow money for various purposes, whether it’s home improvements, repairs, or medical bills.

Personal loans let you borrow money for any purpose, but to snag an affordable rate on a personal loan, you generally need a strong credit score when you apply.

On the other hand, if you own a home, you may be able to qualify for an affordable home equity loan, even if your credit isn’t all that great. Like personal loans, home equity loans allow you to borrow money for any purpose. A lot of people take out home equity loans to fix up their homes, but you can take that cash and use it to go on vacation if that’s what you want (though that’s really not an advisable route to take).

Home equity loans can also, in many cases, come with lower interest rates than personal loans. As such, they may seem like the better option when it comes to borrowing money. But here’s why a personal loan may be a slightly less risky bet.

Secured versus unsecured loans

When you take out a personal loan, you don’t put up a specific asset as collateral for that loan. That’s why your credit score is so important when applying for a personal loan. Since the loan itself isn’t attached to an asset your lender can sell to get repaid, your lender needs to rely on your borrowing history and creditworthiness to decide whether to loan you money or not.

Home equity loans, on the other hand, are secured loans, and the homes being borrowed against serve as collateral for them. If you take out a home equity loan and fall behind on your payments, your lender will have the right to foreclose on your home, just as you’d face foreclosure for falling too far behind on your mortgage payments.

It’s for this reason that homeowners may prefer to borrow money via a personal loan, even if that means getting stuck with a slightly higher interest rate in the process. That way, they don’t put their homes at risk.

Of course, that doesn’t mean there aren’t consequences for not paying off a personal loan on time. If you fall behind on your payments, your credit score could take a major hit. From there, it could become very difficult to borrow money again when you need to. Furthermore, if you fail to repay a personal loan, your lender could seek to garnish your wages. But with a personal loan, you don’t run the risk of losing your home.

What’s the right call?

Ultimately, any loan you take out should be a loan you have the ability to repay. If you borrow responsibly via a home equity loan, you can minimize your risk of losing your home. So you don’t necessarily need to shy away from this option if it means snagging a lower interest rate on the sum you borrow. But at the end of the day, you might be more comfortable with the idea of a personal loan, and that’s okay, too. Just make sure not to get in over your head.

— Maurie Backman

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Source: The Motley Fool