More Americans are turning to personal loans to pay for major life milestones, minor emergencies, debt consolidation and other financial needs.
“Personal loans give you flexibility,” says John Ulzheimer, a credit expert formerly with FICO and Equifax. “You can use the money for anything you want. You can use it to pay for a wedding, pay down credit card debt or student loan debt.”
But how do personal loans stack up to other sources of financing? Bankrate breaks it down by comparing personal loans vs. home equity, HELOCs, credit cards and alternative personal loan products.
Home equity vs. personal loan: Which should you choose?
If you’re a homeowner looking into personal loans, you may want to consider tapping into your home equity instead, either through a home equity line of credit (HELOC), a second mortgage or a cash-out refinance.
The benefit of using home equity is that the rates on these products are considerably lower than personal loans. You might see home equity rates as low as 4-8%, while a personal loan interest rate could range from 5-36%, depending on the lender and your financial situation.
The other benefit of home equity loans and lines of credit is that you can often deduct the interest when filing your income tax return, Ulzheimer says.
The downside is that these loans are secured by your home, so if you have trouble making payments, you could lose your house, says Nicol Matthews, chief operating officer at Charlotte Metro Federal Credit Union in North Carolina. That’s not the case for personal loans, which are unsecured.
Cash-out Refi and HELOC vs. personal loans
The rate on a HELOC also isn’t fixed like it is on a personal loan. Most HELOCs are tied to the prime rate — a common benchmark for consumer and business loans — which is also pegged to the federal funds rate, says Pava Leyrer, chief operating officer at Northern Mortgage Services in Grand Rapids, Michigan.
If the Federal Reserve increases that rate, then the HELOC rate will also go up.
Leyrer says some banks charge annual fees between $50 and $95 to keep a HELOC open, and homeowners need to hold at least 10% equity in their home to get a line of credit.
To do a cash-out refinance, homeowners need even more, at least 15% equity. And cash-out refinances can come with hefty closing costs, anywhere from several hundred dollars to a couple of thousand, says Leyrer. That may be enough to make a personal loan the savvier choice for some consumers.
Credit cards vs. personal loans
Credit cards seem like an obvious place to turn when you need emergency funds. They’re easy because they’re often already in your wallet and you don’t have to go through an application process.
Once you have a credit card, you can usually get a cash advance, as long as the card’s not maxed out. This is the case even if your financial situation has changed since you got the card.
Still, credit card interest rates are often in the double-digits, with cash advance rates even higher. Both are anchored to the U.S. prime rate, which means when the Fed raises rates, those rates increase, too.
Matthews says that her credit union offers credit card rates that are slightly lower than personal loans rates if your credit score is high enough. Still, she thinks a personal loan invites less potential trouble.
“You have a set term and set payment. You know if you do a 3-year loan, it will be paid off in 3 years,” she says. “The rate on the card is variable, so your payment can change. You can also add to the credit card balance,” meaning it will take longer to pay off.
Traditional vs. alternative personal loans
Personal loans definitely come out on top when stacked up against what Ulzheimer calls “second-tier lending options” such as pawn loans, payday loans or title loans, which typically come with sky-high interest rates and often predatory terms.
“Personal loans once had a reputation as being a subprime product,” he says. “But that’s not a deserved one now.”