Should you get a personal loan instead of a HELOC or cash-out refinance?

Personal loan vs. cash-out refinance or home equity loan

So you want to borrow some money and you’re not sure about the right type of loan. Should you get a personal loan, home equity loan, or opt for a cash-out refinance?

It may all look mysterious and complicated from a distance. But you’ll probably be able to decide on the sort of borrowing that best meets your needs.

That’s because, once you take a closer look, each different loan type has advantages catering to certain situations. Surprisingly, you might find that personal loans are quite the competition to more traditional home finance.

Personal loans are “unsecured,” putting your home at less risk

Secured borrowing happens when you provide security for a loan. You offer collateral and give the lender permission to repossess or foreclose on it if you default on the loan.

With a mortgage, your home is the collateral. A “first” or “primary” mortgage is usually the big one that you borrowed to buy the home. And you may have one or more second mortgages (typically home equity loans or home equity lines of credit [HELOCs]) that are also secured on your home.

So, with these, you’re quite literally putting your home on the line. And it’s at risk if you fail to keep up payments.

A personal loan is a type of unsecured borrowing.

A personal loan is a type of unsecured borrowing. The lender has no direct access to seize a particular asset.

There are advantages and disadvantages to this. Rates are typically higher for unsecured borrowing. Plus, the lender can demand repayment by other means if you stop making payments.

Personal loans come with faster closings

A personal loan already comes with one obvious pro. You don’t have to put your home on the line. And one con. You’ll likely pay a higher interest rate.

A second pro is that you’ll almost certainly get your money much sooner than with a refinance or home equity product. With those, it often takes 30-45 days to get your hands on the cash. With a personal loan, it rarely takes longer than a week and you can receive it in 24 hours.

But there’s a third pro that often clinches it for borrowers: closing costs.

Upfront borrowing costs

Closing costs on a personal loan

It can cost you thousands to close a mortgage. But personal loans typically come with low or zero set-up costs.

And that can make an enormous difference to the economics of borrowing. A personal loan is often best when you need small or medium-sized amounts: say, in the hundreds, thousands or low tens of thousands. And that contrasts heavily with home equity products (loans or lines of credit) and cash-out refinancings.

Closing costs on a cash-out refinance vs. a personal loan

Imagine you want to borrow $10,000. You’ll pay little or nothing on a personal loan. But you could pay a lot for a cash-out refinance. Your closing costs would be around 3 percent of the amount you borrow.

And you wouldn’t be borrowing $10,000. You’d be borrowing that amount plus your current mortgage balance. So suppose you currently owe $190,000. You’d pay closing costs on $200,000. So your closing cost bill for a cash-out refinance could be $6,000 for a $10,000 loan!

That would only make sense if your refinance brought other benefits, such as a lower rate or monthly payment.

Certainly, you should think very hard before you refinance to a higher rate. You might still get a lower monthly payment if you’ve had your mortgage for several years. But it will cost you dearly in the end.

Related: 4 cash-out refinance options that put your home equity to work

Closing costs on home equity products

True, home equity products typically come with much lower closing costs than full-blown cash-out refinances. But they can still run to 2 percent-5 percent of the amount you borrow. Of course, that amount will be lower because it would, in this case, be “just” $10,000.

But it could still be several hundred dollars.

“No closing cost” mortgages

It’s worth mentioning zero-closing-costs deals on both refinances and home equity products. These are plentiful but you need to understand how they work.

Ones that are truly free are rare. And you almost always pay a higher interest rate for them. So they might work for you but you have to do the math to see the true cost.

Personal loans vs. home equity line of credit (HELOC)

We’ve already established that a cash-out refinance is worthwhile only if you’re borrowing very large sums or if it brings other benefits such as a lower monthly payment or mortgage rate. But what about home equity products?

Related: Cash-out refinance vs home equity loan: The better deal might surprise you

These are often a sensible middle ground. Closing costs are affordable and the interest rate can often be significantly lower than that for a personal loan. But the only way to be sure is to explore the market for all the competing products and compare overall costs.

But don’t forget that point about secured/unsecured borrowing. You might be willing to pay a little more for a personal loan over a HELOC because you won’t be putting your home on the line.

Barriers to borrowing with mortgage loans

Whatever sort of loan you want, your credit score will play a huge part in determining your costs.

If your credit is bad (below 620 for some personal loan lenders), you might not get a loan at all. And if it’s only poor or fair, you’ll have to pay a much higher interest rate.

So the better your score, the less you’re going to have to pay. If you can (and need to), it might be better to take some time to improve your score before you apply for a loan.

Related: Guide to improving your credit score

A personal loan has fewer barriers

There are lower barriers for personal loans compared to cash-out refinances or HELOCs:

1. You don’t have to be a homeowner
2. You don’t have to prove market value for the home via an expensive, time-consuming appraisal
3. The home doesn’t have to be in good condition (often, you need the cash to fix up the home)
4. You usually can’t take out all the equity in your home. You’ll likely need to retain an equity cushion of maybe 10-20 percent of the appraised value of the home

If that last one’s an issue for you, you may be able to hunt down a more sympathetic lender. But you’d likely have to be a good borrower in other respects or be willing to pay a much higher interest rate.

Your choice — based on your situation

Sometimes a personal loan is the smartest choice. Sometimes it’s not. At least you now know how to decide.

So get going. Explore the deals on offer and do the math to see which will cost you least, both each month and over the lifetime of the loan.