When people need to borrow money, a home equity loan is often their first choice. But there are times when an unsecured personal loan may be the better option.
Perhaps they need the money quickly. Maybe they don't need to borrow that much. Perhaps they don't want to put their home on the line or tie up their home equity for a loan. Maybe they don't have any home equity. It could be they don't own a home to begin with.
Lending for unsecured personal loans dried up during the Great Recession, but has seen a rebound in recent years as lenders have become more willing to issue loans without collateral. And they're not limited to borrowers with high incomes and excellent credit – many lenders will accept borrowers with limited incomes and lower credit scores as well.
So when would you use a personal loan? Here's a quick rundown of the advantages and disadvantages:
- No home equity required
- No risk of foreclosure if you don't repay the loan
- Quick turnaround – often 3-5 days
- Simplified application process
- Rates usually lower than on credit cards
- Can be costly for borrowers with weak credit
- Borrowing limits may be lower than on a home equity loan
- Shorter repayment period
- Interest usually not tax-deductable
About personal loans
Unlike mortgages, where lending guidelines are somewhat consistent, personal loans are all over the map. Credit scores, income requirements, minimum and maximum lending amounts can vary widely from lender to lender.
The general rule is that you need good credit to obtain an unsecured personal loan, and many lenders require FICO scores of 700 or above to qualify. At the same time, there are also a lot of lenders with far more lenient standards, approving borrowers with scores as low as 600-640.
Same for income. Some lenders demand annual income in excess of $70,000; others will accept borrowers in the $10,000-$20,000 range.
Loan amounts vary too. Most lenders cap their personal loans in the $20,000-$50,000 range, though a few will go as high as $100,000 for well-qualified borrowers. For borrowers looking for a small personal loan, minimum amounts typically range from $1,000-$5,000, though some will allow you to borrow as $500.
Many, but not all, lenders will charge an upfront origination fee on personal loans, typically ranging from 1-5 percent.
The application process is simpler than for a home equity loan or mortgage, and the turnaround is faster as well. Borrowers looking for a quick personal loan can often receive their funds within 3-5 days after applying.
Repayment periods for personal loans are relatively short, often 3-5 years, though some lenders will go longer. There may be prepayment penalties if you pay the loan off ahead of schedule.
The best personal loans will combine a low interest rate, little or no origination fees and allow adequate time for you to repay the loan. They also should allow you to borrow enough money to meet your needs. Finding a personal loan that balances all those priorities can be a challenge, so it's a good idea to check out as many lenders as you can before committing.
Personal loan rates
What you can borrow and what you'll pay are highly related to your credit score and income. The best personal loan rates are comparable to what you might get on a home equity loan, but those are for borrowers with excellent credit and good incomes.
Borrowers with weak credit can qualify, but should expect to pay substantially higher rates. A single lender may charge personal loan rates that range from 6 percent to 36 percent, depending on the borrower's financial profile and the amount and duration of the loan.
Unsecured personal loans are usually written as fixed-rate loans in which you receive your money as a single lump-sum payout, though some lenders offer adjustable-rate personal loans as well. A few also offer personal loans as a revolving line of credit with an adjustable rate.
Personal loans for home improvements
Unlike a home equity loan, the interest paid on a personal loan is usually not tax deductable. There is one exception, however – you may be able to deduct the interest if using the loan for certain home improvements. To qualify, the improvements must be what are called capital improvements, which increase the value of your home – they can't be simple repairs.
Even without the tax deduction, unsecured personal loans can be good choices for borrowers who lack home equity and are seeking a home improve. That includes owners of manufactured homes or houses on leased land, which don't qualify as real estate.
While in many cases you can use a personal loan for any purpose you wish, some lenders may require that you show plans for how you plan to use the money and the funds may be restricted to a specific purpose, such as paying off credit cards.
Where to apply
To apply for a personal loan, you can go to virtually any bank or credit union. Many lenders now offer personal loans online, which saves time and can speed the application process for people seeking quick personal loans.
Some lenders will only grant personal loans to their existing customers, so you may need to set up an account and perhaps go through a waiting period to get a loan through them. But others will accept any borrower who meets their credit worthiness and other loan guidelines, allowing you to shop around to find the best personal loan rates and terms.