Looking to buy a home? Or consolidate debt? Personal loans and mortgages are both ways to borrow money, but each has a different purpose and requirements. Let’s dig into the difference between a personal loan and a mortgage, so you can choose the best loan for you.
A personal loan is an unsecured loan used for various purposes, while a mortgage is a secured loan specifically used to purchase or refinance real estate.
Looking to buy a home? Or consolidate debt? Personal loans and mortgages are both ways to borrow money, but each has a different purpose and requirements. Let’s dig into the difference between a personal loan and a mortgage, so you can choose the best loan for you.
Is it Better to Get a Personal Loan or a Mortgage?
Whether it’s better to get a personal loan or a mortgage depends on why you need the loan. Here’s a closer look at each type of loan.
Personal Loans at a Glance
A personal loan is a loan that can be used for any purpose. These loans are typically unsecured, which means that there’s no collateral securing the loan. Let’s say you buy a car using an auto loan. If you stop paying on the loan, your lender will repossess the car. The car serves as collateral.
With a personal loan, there’s usually no collateral, which makes it riskier for the lender. That means the interest rate will be higher than a secured loan. Personal loans also tend to have shorter repayment periods. A range of 3 to 5 years is typical.
A personal loan could be a good choice for consolidating debt, dealing with medical debt, moving expenses, making home repairs and other expenses. It’s typically not the best choice for buying a home, as these loans have higher interest rates than mortgages, shorter repayment periods, and are limited to $100,000.
Mortgages at a Glance
A mortgage is a loan you use to buy property. Also referred to as mortgage loans or home loans, these loans are secured by the property you buy. In other words, if you stop paying on your mortgage, your lender can foreclose on your home and sell it to pay off your mortgage balance.
Since home loans are secured, lenders offer low mortgage rates. These loans also have long repayment periods of 15 to 30 years.
Unlike a personal loan, you typically have to make a down payment when you take out a mortgage. Many borrowers aim for 20% to avoid paying for private mortgage insurance (PMI). But you can qualify for a mortgage with a lower down payment. V
A loans, which are offered to qualifying service members and veterans, don’t require any down payment. USDA loans also don’t require a down payment, and FHA loans have a low down payment requirement of 3.5%. If you’re a first-time home buyer, an FHA loan is a good option because of its low down payment and flexible credit requirements.
What is a Personal Loan?
A personal loan is a type of loan that you can borrow from a bank, credit union, or online lender. Unlike specific-purpose loans like mortgages, personal loans can be used for a variety of purposes, such as debt consolidation, paying for medical expenses, funding home improvements, or covering unexpected financial emergencies.
Personal loans are typically unsecured, meaning they do not require collateral like a car or house to secure the loan. Instead, lenders assess the borrower's creditworthiness based on factors such as their credit score, income, employment history, and debt-to-income ratio. The interest rates on personal loans can vary depending on the borrower's creditworthiness and the lender's terms.
Personal loans are usually repaid in fixed monthly installments over a set period of time, which can range from a few months to several years. The loan terms, including interest rates, repayment period, and loan amount, are agreed upon between the lender and the borrower before the loan is disbursed.
Personal Loan Requirements
Personal loan requirements vary significantly by lender. Here are the factors typically considered:
- Your credit score: This is a 3-digit number generated by computer modeling. It gives lenders an idea of how you’ve handled credit in the past, which they use to decide how likely you are to repay your loan. A score of 670 or above is considered good. If your score is below 670, you may still qualify for personal loans, but the interest rate may be high.
- Your income: The lender wants to be sure you have enough income to cover the loan.
- Your debt-to-income (DTI) ratio: Lenders look at the relationship between your debt and your income. To do this, they add up your total monthly debt payments, including your personal loan, and compare it to your pre-tax income. If you have $1,500 in total debt payments and a pre-tax income of $3,500, you have a 43% DTI ratio. Lenders generally prefer a DTI ratio of 43% or less, but some may allow higher.
Personal Loan Pros and Cons
What should you keep in mind if you’re considering a personal loan? Let’s take a look.
Pros
- Flexibility: You can use a personal loan for any purpose.
- Easy to get: Personal loans tend to have flexible requirements, and some lenders specialize in working with borrowers who have less-than-perfect credit.
- Fast funding: Some lenders offer next-day loan funding, so if you’re experiencing an emergency, you can get your funds sooner rather than later.
Cons
- Higher interest rates: It varies based on the lender and on your credit score, but personal loans tend to have higher rates than other types of loans.
- Short repayment terms: You typically only have a few years to pay off a personal loan, which means the payments can be steep.
Best Personal Loan Lenders
Which personal loan lender should you choose?
- Best For:No origination feesVIEW PROS & CONS:securely through SoFi Personal Loans's website
- Best For:Quick fundingVIEW PROS & CONS:securely through Figure Personal Loan's website
What is a Conventional Mortgage?
A conventional mortgage is a mortgage that isn’t part of a government program. These mortgages tend to have more stringent requirements than government-sponsored loans.
There are 2 types of conventional mortgages:
- Conforming loans: These loans follow the requirements of Freddie Mac and Fannie Mae, which are government-sponsored businesses that buy mortgages. These loans have limits.
- Non-conforming loans: These loans are much more flexible. They don’t have to meet any specific requirements, so they vary by lender. If you’re considering a non-conforming loan, look closely at the terms and make sure you’re comfortable with them.
Conventional mortgages can also have PMI. PMI is insurance that protects the lender if it forecloses on your mortgage. In most cases, you have to pay for PMI if you make a down payment of less than 20% on a conventional mortgage. You may also have to pay PMI if you refinance into a new mortgage and have less than 20% equity in your home.
Mortgage Loan Requirements
What are the requirements to qualify for a mortgage? Let’s take a look.
- Down payment: With a conventional mortgage, you’ll typically need to make a down payment of at least 5% unless you’re a first-time home buyer. First-timers can make down payments as low as 3%. FHA mortgages allow down payments as low as 3.5% if you have a credit score of 580 or higher and 10% if you have a score of 500-579. VA and USDA loans don’t have a minimum down payment requirement.
- Credit score: The minimum credit score varies by lender. Most lenders require a credit score of 620 or higher, but some will accept lower credit scores, especially for government-backed loans.
- DTI ratio: Lenders prefer a DTI of 43% or less, but some will allow you to go up to 50%, especially if you have compensating factors. For example, if you have a significant amount of savings, a lender may allow you to have a higher DTI ratio.
- Loan limits: Some mortgage types have limits. These limits typically vary by area. Conforming conventional mortgages have a loan limit of $510,400 in most areas. Higher-cost areas can have loan limits up to $765,600. FHA loans have a loan limit of $331,760 in low-cost areas, and high-cost areas have loan limits up to $765,600.
Mortgage Pros and Cons
Here are the advantages and disadvantages of a mortgage.
Pros
- Low interest rates: Compared to personal loans, credit cards and other types of loans, mortgages have low interest rates.
- Long repayment terms: Longer repayment terms mean you have lower payments each month.
- Flexible credit requirements: While you may have to pay a higher interest rate, you can qualify for a mortgage with a 620 credit score (and sometimes even lower).
Cons
- Lengthy loan process: Applying for a mortgage is an involved process. You need to provide documentation of your income, bank statements, and tax returns. The lender will appraise the home to confirm its value. It often takes a month or longer to complete the mortgage process.
- May have to pay PMI: Depending on your down payment, you may have to pay PMI, which makes your monthly payments higher. The good news is that you can get rid of PMI once you’ve paid down your mortgage to 80% of the balance or more.
Best Mortgage Lenders
Which mortgage lenders are the best?
Choosing the Right Financing Option
Whether you’re getting a personal loan or a mortgage, the process for choosing the right loan is similar.
Contact multiple lenders to compare offers and get a feel for the customer service from each lender. Once you have a few offers in hand, review each carefully. Look at the interest rate, origination fees, how long you have to repay the loan and whether there’s a prepayment penalty.
Take a closer look at the lender when you find a promising offer. Does it offer the service options you prefer? For example, if you prefer doing everything online, consider working with an online mortgage lender. If you prefer in-person service, check out a loan with a local bank or credit union.
With all those factors in mind, move forward with the lender that’s right for you. With a personal loan, you’ll typically just need to complete an application. For a mortgage, you’ll need to complete an application and provide financial documents.
If you have questions or concerns about any type of loan, don’t hesitate to talk to your lender. A good lender will answer your questions and make sure you’re fully informed about your loan. Start with our list of recommended lenders to find the right personal loan or mortgage today.
Frequently Asked Questions
What is the difference between a loan and a mortgage?
Loans are borrowed money from a lender and can be secured or unsecured. Mortgages specifically finance property purchases and have longer repayment terms.
Is a personal loan bad on your credit?
Taking out a personal loan can both positively and negatively impact your credit score. Making timely payments can improve your credit, but missing payments can damage it.
Is it better to get a personal loan or refinance your home?
Whether to choose a personal loan or refinance your home depends on individual circumstances. If you need a small amount of money, a personal loan with a good credit score is better. If you need a larger amount and have significant home equity, refinancing may be the better choice.
