Home Equity Loan vs. Personal Loan

Why securing consolidated debt with collateral can be a risky proposition.

Weigh risk against return with home equity loan vs. personal loan comparisons

Using a loan to consolidate credit card debt can be extremely helpful. With the right credit score, you can qualify for a loan at a low interest rate. This allows you to pay back what you owe in a more efficient way. It minimizes the total cost of debt elimination and often means that you pay less each month, too.

However, although loans can be useful for consolidating debt, not all loans are created equal for this purpose. The information below helps you understand the key difference between consolidating with these two types of loans. If you have questions or need to discuss your best options for debt relief with a certified professional, we can help. Call Consolidated Credit at 1-800-435-2261 to schedule a consultation with a certified credit counselor at no charge. You can also complete our online application.

Collateral makes all the difference

The difference between a home equity loan and personal loan is collateral. A personal loan is unsecured debt, meaning it is not backed up by collateral. If you default on unsecured debt due to nonpayment, the lender must sue you in civil court to recoup losses.

By contrast, a home equity loan is secured debt. You borrow against the value of your home. This means your home acts as collateral. If you default on a secured debt, the collateral can be taken without an additional court order. In other words, if you fall behind on the payments, you could be at risk of foreclosure.

Securing a loan usually means better rates with a lower credit score…

People often turn to home equity loans because it’s easier to get approved. A secure loan means you can qualify for a lower interest rate without a need for excellent credit.  The lender relaxes their lending standards because the loan is back up using your home as collateral. That means less risk for the lender, which leads to better rates and lending terms.

This is why using a home equity loan to eliminate credit card debt can be so tempting. You can get a low interest rate and good terms even with a weaker credit score. It can seem like a good path out of debt. As long as you keep your job and keep up the payments, you can pay off the loan without trouble.

… But the risk you add is often not worth the cost savings

However, experts usually agree that the rate reduction and ease of qualifying is not worth the risk added. As mentioned above, borrowing against the value of your home is fine as long as your financial situation doesn’t change. Still, financial changes happen even if you don’t intend them. You could lose your job, the real estate market could take a bad turn, and suddenly your home is at risk of foreclosure.

Now consider the risk if you’re in the same situation with an unsecured personal loan. You can still consolidate your credit cards at a lower interest rate. However, now if your finances take a turn for the worse, you won’t lose anything if you default. If you default on the unsecured loan, it may pass to a third-party collector.  The lender or collector would have to sue you in civil court to recoup any losses. You might face a lien or wage garnishment, but your home would be protected from foreclosure.

If you can’t qualify for unsecured, consider other options before you tap equity!

When seeking debt relief for unsecured credit card debt, it’s best to keep your solution unsecured as well. If you’re looking into do-it-yourself debt consolidation, see if you can qualify for an unsecured personal debt consolidation loan.  This would consolidate your credit card debts into a single monthly payment at a low interest rate.

If you can’t get approved or don’t qualify at a good rate, a home equity loan SHOULD NOT be your next step. Instead, you should talk to a certified credit counselor to review your other options. They may recommend that you enroll in a debt management program. This helps you avoid using a home equity loan that would just increase your risk unnecessarily.

Another risk with reconsolidation

In addition to the risk of collateral, using a home equity loan for credit card debt also creates another challenge. Namely, you can’t re-consolidate later if your debt elimination plan doesn’t work.

When you consolidate with an unsecured personal loan it means that the debt remains unsecured. This means you can reconsolidate the loan later with another debt relief option if you need to do so. Your options for debt relief remain open. You can take out another consolidation loan or you can include the consolidation loan in a debt management program.

On the other hand, if you consolidate with a home equity loan the debt is now secure. That means you can’t include it in any unsecured debt relief option. For instance, it would no longer be eligible for inclusion in a debt management program.

Always consult an expert before you access home equity

In some circumstances, using a home equity loan to take advantage of your equity can be a smart financial move. However, you should always consult with a certified professional before you move forward. If you’re considering using your home equity, call Consolidated Credit at 1-800-435-2261 to speak with a HUD-certified housing counselor. Together you can evaluate the risks and benefits before you make any lending decision.