Personal loans and home equity loans bear many similarities. They are both issued in the form of lump-sum payments, they are both repaid over a series of monthly instalments and they can both be used for almost any legal purpose.
But there is one major difference between the two in relation to how they are issued. Personal loans are almost always unsecured and are therefore issued on the basis of the borrower’s financial status. By contrast, a home equity loan is secured against the borrower’s home, rendering their financial status far less important.
When a borrower offers their home as security for a loan, they can access much larger sums of money than would be available with a personal loan. These home equity loans can also attach lower interest rates and borrowing costs, as they are generally seen as safer by the lender.
Even so, there are pros and cons to both options to be aware of. If you are looking to borrow money for any purpose and both types of loans are available to you, it is vital to make the right choice to suit your requirements and your budget.
Personal Loans: Application and Approval
No security (collateral) must be provided when applying for an unsecured personal loan. Instead, applications are considered by way of their overall merit, based primarily on the following:
• The credit score of the borrower at the time of applying
• The applicant’s employment status and income level
• All of the applicant’s current outgoings and existing debts
• Whether they have previously declared bankruptcy
• Provision of recent bank statements (usually three months)
The size of the loan being applied for will also factor into the decision reached by the lender. For larger loans, applicants are expected to have better credit scores, higher income levels, and minimal existing debts.
Approval for an unsecured personal loan usually takes 1 to 7 business days, while decisions in principle can be returned almost immediately. Unsecured personal loans are rarely issued in sums higher than £10,000-£15,000, with loan values starting from as little as £500. This makes personal loans ideal for covering the costs of smaller purchases, projects, and investments if you only need a small sum of money to tide you over.
Interest rates and borrowing costs vary significantly from one product and lender to the next – anything from 2% to 10% APR. Independent broker support is therefore essential in order to ensure you get a competitive deal from a top-rated lender.
Home Equity Loan Application and Approval
A home equity loan is slightly more complex to arrange, as your lender will first need to confirm the current market value of your home. After which, the amount of equity you have in your property will determine how much you can borrow.
For example, if your home is valued at £300,000 and you have repaid £250,000 of your mortgage, this is your equity. A lender may be willing to offer a home equity loan to a maximum LTV (loan to value) of 80%, meaning you could borrow 80% of this £250,000 – i.e. £200,000.
Of course, this does not mean that you must take out the highest value loan possible against your home. A home equity loan can typically be taken out starting from £10,000 and up and is therefore ideal for funding more extensive projects and investments.
Your income level and credit score will be taken into account, but will not necessarily count you out of the running for a home equity loan.
With all the required paperwork in place, some types of home equity loans (like bridging loans) can be arranged within a few working days.
As with unsecured personal loans, home equity loan costs vary significantly from one product to the next. The interest rate you are quoted will be influenced by how much you borrow, the size of the LTV, the length of the repayment period, and more.
But as security is provided as an insurance policy for the loan, lenders typically offer home equity loans with lower interest rates and borrowing costs. Though again, it is essential to seek independent broker support, in order to ensure you get a good deal.
What Is the Most You Can Borrow with a Home Equity Loan?
The fact that a home equity loan can be repaid over anything from 5 to 30 years makes it a hugely flexible and affordable facility. This also opens the door to much larger loans, enabling homeowners to tap into the equity they have tied up in their properties.
In terms of the maximum loan size available, all lenders have their own unique policies. As a general rule of thumb, home equity loans are issued with a maximum LTV of 75% to 85%. Some specialist lenders will offer loans with a higher LTV, just as others will limit their maximum home equity loans to 60% LTV or less.
This, therefore, means that the value of your home will be the main determining factor when it comes to how much you can borrow. But it is also important to acknowledge how a higher LTV typically translates to a higher APR.
This is not always the case, but lower LTV home equity loans often attach lower overall borrowing costs.
• The maximum loan size you will be offered will be tied to the total value of your home, or how much of your mortgage you have paid off (your equity).
• It is possible to borrow up to 85% of the value of your home, but some lenders are more restrictive with maximum LTVs.
• Borrowing as much as you possibly can is not usually advisable, as higher LTVs typically attach higher borrowing costs.
• Your income level and credit score will be taken into account, but will not necessarily count you out of the running for a home equity loan.
• A home equity loan can be repaid over anything from 5 to 30 years, but prompt repayment usually results in lower borrowing costs.
Before applying, consult with an independent broker to discuss your suitability for a home equity loan, in line with your intended applications for the funds.
Applying for a home equity loan also means being mindful of some of the potential downsides of this kind of secured lending.
• Are you 100% confident in your long-term ability to comfortably afford the monthly repayments?
• Have you considered the possible consequences in the event you are unable to repay your loan?
• What is your lender’s policy regarding late payments, missed payments, and other potential issues that may arise?
• Is the APR on the loan competitive after taking into account all other associated borrowing costs?
• Will you have the option of repaying your loan early, and what kinds of fees/penalties may apply if so.
• Have you compared the market in its entirety to ensure you are getting an unbeatable deal?
These and other considerations will be examined in-depth during your initial consultation, making experienced broker support mandatory.
Does a Home Equity Loan Always Attach Lower Interest Rates Than a Personal Loan?
The short answer is no, as there are instances where a personal loan can be the more affordable option.
Over recent years when interest rates hit record lows, unsecured personal loans were being issued with impossibly low-interest rates of less than 1%. You could therefore borrow £5,000 over the course of a few years and pay back almost the exact same amount, shy of a token APR as low as 0.5%.
In such instances, this would be the option to go for.
But in a more general sense where interest rates are not quite so low, secured borrowing is almost always cheaper. The same can also be said when looking to borrow significant sums of money, which are often only available in the form of secured loans.
As with all financial products, it depends entirely on your requirements, your budget, and how you intend to spend the funds. Some unsecured loans are cheaper than secured loans and the same is also true in reverse.
This is something that emphasises the importance of comparing the market in full while considering all available products from the UK’s highest-rated lenders.
The Bottom Line…
There are instances where unsecured personal loans and secured home equity loans could both be viable options. When you are looking to fund a purchase, a project, or an investment of some kind. Figuring out which is the most cost-effective option means carefully considering the full range of products available and comparing deals from an extensive network of lenders.
While it can be tempting to dive into the first affordable deal that comes along, independent broker support could save you time, effort, and money on any type of secured or unsecured loan.For more information on any of the above or to discuss your requirements in more detail, contact a member of the team at UK Property Finance today