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Loans have become an integral part of American financial life. We need a mortgage to buy our first home, and an auto loan to purchase a car. More recently, people are turning to personal loans to cover surprise bills and avoid high-interest credit card debt. But just because you need a loan doesn’t mean a lender is going to give you the loan — and interest rate — you want.

If you’re struggling to qualify for a loan, a friend or family member may be able to help by becoming a co-borrower. By leveraging their income, credit score, and financial history, you may qualify for better loan terms. Let’s dive into the details.

Understanding Co-Borrowers

As you’re considering your options, a natural first question may be, what is a co-borrower? Essentially, a loan co-borrower takes on the loan with you, and their name will be on the loan with yours. They will be equally responsible for paying the loan back and will have part ownership of whatever the loan buys. When you take out a mortgage with someone, the co-borrower will own half the home.

Spouses often co-borrow when buying property, and when taking out a personal loan for a home improvement or remodeling project. In other circumstances, two parties become co-borrowers in order to qualify for a larger loan or better loan terms than if they were to take out a loan solo.

Having a co-borrower can help two people who both want to achieve a financial goal — like first-time homeownership or buying a new car — put in a stronger application than they might have on their own. The lender will have double the financial history to consider, and two borrowers to rely on when it comes to repayment. Therefore, the loan is a less risky prospect, which may translate to more favorable terms.

Recommended: All About Variable Interest Rate Loans

Qualifying as a Co-Borrower

If you’re planning to have a co-borrower on your personal loan application, it helps to understand what criteria you both must meet in order to be accepted by the lender. Let’s take a closer look at common factors lenders consider.

Credit Score

A credit score can have a significant impact on whether your loan application is approved and what terms you’re offered. There’s no magic number, but generally speaking, lenders prefer to see a score of 670 or higher. You and your co-borrower may want to check your credit scores for free before you apply.

Proof of Income and Employment

To help them determine whether co-borrowers can afford loan payments, a lender will likely want to see proof of a stable income and employment. You both may be asked to provide recent pay stubs, tax returns, and bank statements. You might also be asked to show a letter from your employers verifying your employment status, how long you’ve both been employed, and your salaries.

Debt-to-Income Ratio

Debt-to-income ratio, or DTI ratio, is a comparison of your monthly debts to your gross monthly income (before taxes). Lenders use this information to help determine how risky it would be to loan money to a borrower. It can affect your ability to borrow money and the interest rate you’ll receive. Generally, lenders like to see a DTI that’s no higher than 36%, though there may be some wiggle room.

In addition to the above, lenders also usually consider:

•   Financial history. This includes recent bankruptcies, judgments, and liens.

•   Age. Many lenders have a minimum age for co-borrowers, typically 21 to 25 years of age.

•   Citizenship. Co-borrowers generally must be either citizens or permanent residents of the U.S.

Co-Borrower Process

Applying for a loan with a co-borrower? The application process is fairly similar to the one you’d follow if you were applying alone.

A good first step is to reach out to your lender and start the prequalification process. If your co-borrower has a strong credit profile, that could improve your odds of qualifying for better rates and terms.

Next, you and your co-borrower will need to complete the loan application. You’ll also both undergo credit checks, and the lender will evaluate your finances. You may be asked to provide documentation like pay stubs, bank statements, or tax forms.

Within a few days or so, you’ll find out if you’re approved and what your loan terms are. Once you agree to the terms, your loan funds will be disbursed, usually within a week. Your lender will also share details about how to make monthly payments.

Co-Borrower vs. Cosigner

A cosigner plays a slightly different role than a co-borrower. A cosigner’s income and financial history are still factored into the loan decision, and their positive credit standing benefits the primary applicant’s loan application. But a cosigner does not share ownership of any property the loan is used to purchase. And a cosigner will help make loan payments only if the primary borrower is unable to make them.

Cosigning helps assure lenders that someone will pay back the loan. Typically, a cosigner has a stronger financial history than the primary borrower. This can help someone get approved for a loan they might not qualify for on their own, or secure better terms.

No matter which route you choose, there are potential credit implications to keep in mind. For example, when you apply for a loan, the lender will likely do a hard credit pull. This may cause credit scores to temporarily dip for you and your cosigner or co-borrower.

Both parties may also see a drop in their credit score if monthly payments are late or missed altogether. (And remember, cosigners will be on the hook for making loan payments if the main account holder can’t.) On the flip side, on-time payments can help boost or build credit scores.

When should you choose a cosigner vs. a co-borrower? The answer depends on your situation and goals. If you intend on sharing ownership of whatever you buy with the loan, then a co-borrower may be a good choice. If you simply need someone with a strong credit history to bolster your loan application, then consider using a cosigner.

Recommended: What Is Revolving Credit?

The Takeaway

Taking out a loan is a big decision, and doing so with a co-borrower carries additional risks. A co-borrower is a partner in the loan and any property the loan is used to purchase. If one borrower cannot make their payments, the co-borrower will be on the hook for the full amount. But if both parties can come to an agreement about how they’ll handle any financial hardships, co-borrowing can have major benefits. By pooling their income and debt, they may lower their debt-to-income ratio and qualify for a mortgage or personal loan with a lower interest rate and better terms.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

Photo credit: Stocksy

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOPL1222002

Taking out a personal loan can both help and hurt your credit. In the short term, applying for a new loan can have a small, negative impact on your scores, due to the hard inquiry by the lender. If managed well, however, having a personal loan can boost your credit profile over time by adding to your positive payment history and broadening your credit mix. This could make it easier to get approved for loans and credit cards with attractive rates and terms in the future.

Here’s a closer look at how personal loans affect your credit score, both positively and negatively, plus guidelines on when it makes sense to take one out.

How Is Your Credit Score Calculated?

Understanding how personal loans impact your credit starts with knowing how your credit score is calculated. The most common credit scoring model, FICO®, uses five components to calculate your score. Here’s a look at each factor and how much weight it’s given in FICO’s calculation.

•   Payment History (35%): Your record of making on-time payments to lenders is the most important component of your score. This helps creditors determine how much risk they are taking on by extending credit.

•   Amounts Owed (30%): This includes the total amount of debt you currently have and your credit utilization ratio, which measures the percentage of available credit you’re using. If you’re tapping a lot of your available credit on your credit cards, it suggests you may be overextended and, thus, at higher risk of defaulting on a loan.

•   Length of Credit History (15%): This factor takes into account the average age of your accounts, the age of your oldest account, and how long it has been since you used certain accounts. Generally, having a longer credit history can positively affect your score.

•   New Credit (10%): A small but still important part of your score is how much new credit you’ve recently taken out. Opening new accounts or having too many credit inquiries can temporarily lower your score.

•   Credit Mix (10%): Your credit mix looks at how many different types of credit you hold. Having a variety of credit types — like credit cards, retail accounts, and installment loans — can positively affect your score.

A personal loan can influence several of these factors, for better or worse, depending on how you manage it.

How Do Personal Loans Work?

A personal loan is a lump sum of money borrowed from a lender, such as a bank, credit union, or online lender. Personal loans are typically unsecured, meaning you don’t need to provide collateral (like your car or home), and can be used for various purposes like consolidating debt, covering medical bills, or funding a wedding.

When you take out a personal loan, you agree to repay it in fixed monthly installments over a predetermined period, usually ranging from two to seven years. The interest rate, determined by your creditworthiness, and any lender fees affect how much you’ll pay in total.

Recommended: Is There a Minimum Credit Score for Getting a Personal Loan?

Ways Personal Loans Can Hurt Your Credit

While personal loans can be beneficial, they also have the potential to harm your credit. Here’s how:

Requires a Hard Credit Inquiry

When you apply for a personal loan, the lender typically performs a hard credit inquiry to evaluate your creditworthiness, which can adversely impact your credit score. Hard inquiries remain on your credit report for two years. However, their negative effect on your score is minor (typically 5 points or less) and lasts only about a year.

Note that prequalifying for a personal loan, which involves a soft inquiry, won’t have any impact on your score. This can give you an estimate of the interest rate and loan amount you can expect in a loan offer.

Can Increase Overall Debt

Taking out a personal loan can increase your overall debt, which can negatively affect the “amounts owed” component of your credit score. This may cause you to see a slight drop in your score. However, if you’re consolidating credit card debt, you will reduce that debt by paying it down with the personal loan, and your amounts owed won’t be impacted.

Can Negatively Impact Payment History If You Miss a Payment

Since payment history is the largest factor in credit scoring, missing just one payment on your personal loan can result in a substantial drop in your score. While being just a few days late may not affect your credit, lenders can report payments that are more than 30 days overdue to the credit bureaus. Late payments remain on your credit reports for seven years.

Setting up autopay or reminders can help ensure you make your payments on time and avoid this credit score setback.

Can Shorten Your Credit History

Taking on a new loan can shorten the average age of your credit accounts, which could have a small negative impact on your score. Generally, a longer credit history is considered better than a shorter one.

How Personal Loans Can Help Your Credit

Despite the risks, personal loans can also positively influence your credit when managed wisely. Here’s how:

Can Add to Your Credit Mix

Your credit mix accounts for 10% of your score. Adding a personal loan to your portfolio — especially if you primarily have revolving credit, like credit cards — can enhance your credit profile by showing that you can manage different types of credit responsibly.

Can Improve Your On-Time Payment History

Consistently making on-time payments on your personal loan demonstrates financial responsibility, which can strengthen your payment history — the most significant component of your score. It may take a few months for the benefits to show up but over time, this can positively impact your credit.

May Help Lower Your Credit Utilization Ratio

If you take out a personal loan to pay off high-interest credit card debt (also known as a credit card consolidation loan), you can lower your credit utilization ratio, which is the percentage of your available credit you’re using. A lower ratio — ideally under 30% — is generally beneficial for your credit. However, this strategy only works if you keep your credit card spending low after paying off your balances with the loan.

When to Consider Taking Out a Personal Loan

Even though applying for a personal loan may result in a small, temporary drop in your credit score, there are times when taking on this type of debt can be a smart financial move. Here are some scenarios where you might consider getting a personal loan.

•  You want to consolidate high-interest debt: Personal loans typically have lower interest rates than credit cards, making them an attractive choice for paying off expensive credit card debt. An online personal loan calculator can help you determine how much you could potentially save. If you’re juggling several credit cards, a debt consolidation loan can also simplify repayment.

•  You’re facing unexpected expenses: Medical bills, home and car repairs, or other emergencies can sometimes justify taking out a loan. Using a personal loan may be more cost effective than putting these expenses on your credit card.

•  You have good or excellent credit: The best personal loan interest rates are generally reserved for borrowers who have strong credit. While there are personal loans for bad credit, they typically come with higher interest rates and other less-than-ideal terms.

•  You earn a steady paycheck: Getting a personal loan generally only makes sense if you have a regular income and earn enough to comfortably cover the monthly payments for the term you select.

The Takeaway

Personal loans can have a positive or negative impact on your credit depending on how you manage them. Initially, applying for a personal loan can slightly downgrade your score. This is due to the hard inquiry, as well as the loan’s impact on the average age of your accounts and (potentially) your overall debt load. However, if you repay the loan responsibly, having a personal loan can ultimately help your credit by adding positive payment history, diversifying your credit mix, and — if you use it pay off credit card debt — reducing your credit utilization rate.

Before taking out a personal loan, you’ll want to assess your financial situation, shop around for the best rates and terms, and make sure the monthly payments work with your budget.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

FAQ

Is a personal loan bad for your credit?

A personal loan isn’t inherently bad for your credit, but its impact depends on how you manage it. Initially, applying for a loan may lower your score slightly due to the hard credit inquiry. In addition, taking on more debt can increase your amounts owed, which might affect your score. However, consistently making on-time payments can boost your payment history, a major factor in credit scores. And if you use a personal loan to consolidate credit card debt, you’ll lower your credit utilization ratio (how much of your credit limit you are using), which can positively impact your credit.

Will a personal loan affect my credit card application?

It can. If you applied for the loan recently, the hard credit inquiry may have slightly lowered your credit scores. Having a personal loan can also lower the average age of your accounts and, potentially, increase your debt load, which can negatively impact your credit. Over time, however, having a personal loan can improve your credit profile by adding to your positive payment history and, if you use it to consolidate credit card debt, lowering your credit utilization, making it easier to get approved for a credit card.

Will a personal loan affect my car loan application?

It can. When assessing your eligibility for a car loan, lenders typically consider your credit score, debt-to-income ratio, and overall financial profile. The hard credit inquiry for the personal loan might lower your credit score temporarily. In addition, the added debt from the loan could increase your debt-to-income ratio, making you appear higher risk to a lender. On the other hand, responsible repayment of the personal loan shows financial discipline, which can improve your credit profile over time. Ultimately, this could make it easier to get a car loan with attractive rates and terms.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOPL-Q424-012

Maybe you’ve spent a serious amount of time watching HGTV and now have visions of turning your kitchen into a chef’s paradise. Or perhaps you have an entire Pinterest board full of super-deep soaking tubs that you’re dreaming about.

Either way, the home improvement bug has bitten you, and you’re hardly alone. In the U.S. $827 billion was spent on home improvement from 2021 to 2023, according to the U.S. Census Bureau American Housing Survey. For a bit more context, consider that the average American spent more than $9,542 on home improvement projects in 2023 — with spending up 12% over 2022. That’s a lot more than just buying a new bathroom sink.

While your home might be begging for some updates and improvements, not all of us have close to $10,000 stashed away in a savings account. For many people, realizing their home improvement goals means borrowing money. But how exactly?

Read on to learn about some of your options, including a home equity loan, a home equity line of credit (HELOC), and a home improvement loan. We’ll share the situations in which home equity loans, HELOCs, and home improvement loans work best so you can figure out which home improvement loan option is right for you.

What’s the Difference Between Home Equity Loans, HELOCs, and Home Improvement Loans?

If you’ve figured out how much a home renovation will cost and now need to fund the project, the options can sound a bit confusing because they all involve the word “home.”

What’s more, you may hear the term “home equity loan” loosely applied to any funds borrowed to do home improvement work. However, there are actually different kinds of home equity loans to know about, plus one that doesn’t involve home equity at all.

So, before digging into home improvement loans vs. home improvement loans vs. HELOCs, consider the basics for each:

•   A home equity loan is a lump-sum payment that a lender gives you using the equity in your home to secure the loan. These loans often have a higher limit, lower interest rate, and longer repayment term than a home improvement loan.

•   A home equity line of credit, or HELOC, is a revolving line of credit that is backed by your equity in your home. It operates similarly to a credit card in that the amount you access is not set, though you will have a limit on how much you can access.

•   A home improvement loan is a kind of lump-sum personal loan, and it is not backed by the equity you have in your home. It may have a higher interest rate and shorter repayment term than a home equity loan. What’s more, it may have a lower limit, making it well suited for smaller projects.

Worth noting: If you use your home as collateral to borrow funds, you could lose your property if you don’t make payments on time. That’s a significant risk to your financial security and one to take seriously.

Next, here’s a look at how key loan features line up for these options.

How Much Can I Borrow?

The sky isn’t the limit when borrowing funds. This is how much you will likely be able to access:

•   For a home equity loan, you can typically borrow up to 85% of your home’s value, minus what’s owed on your mortgage. So if your home’s value is $300,000, 85% of that is $255,000. If you have a mortgage for $200,000, then $255,000 minus $200,000 leaves you with a potential loan of $55,000. You can do the math quickly with a home equity loan calculator.

•   For a HELOC, you can often access up to 90% of the equity you have in your home, though some lenders may go even higher. In that case, you are likely to pay a higher interest rate. In the scenario above, with a home valued at $300,000 and a mortgage of $200,000, that means you have $100,000 equity in your home. A loan for 90% of $100,000 would be $90,000. As with other lines of credit, your credit score and employment history will likely factor into the approval decision. To figure out what payments might be on a HELOC, you can use a HELOC repayment calculator.

•   For a home improvement loan, the amount you can borrow will depend on a variety of factors, including your credit score, but the typical range is between $3,000 and $50,000 or sometimes even more.

What Can the Funds Be Used for?

Interestingly, some of these funds can be used for purposes other than home improvement costs. Here’s how they stack up:

•   For a home equity loan, you can certainly use the funds for an amazing new kitchen with a professional-grade range, but you can also use the money for, say, debt consolidation or college tuition.

•   For a HELOC, as with a home equity loan, you can use the money as you see fit. Redoing your patio? Sure. But you can also apply the cash to open a business, pay for grad school, or knock out credit card debt.

•   For a home improvement loan, there is often the requirement that you use the funds for, as the name suggests, a home improvement project, such as adding a hot tub to your property. In some cases, you may be able to use the funds for non-home purposes. Your lender can tell you more.

Recommended: How to Find a Contractor for Home Renovations & Remodeling

How Will I Receive the Funds? How Long Will It Take to Get the Money?

Consider the different ways and timing you may encounter when getting money from these loan options:

•   With a home equity loan, you receive a lump sum payment of the funds borrowed. The timeline for getting your funds can be anywhere from two weeks to two months, depending on a variety of factors, including the lender’s pace.

•   With a HELOC, you open a line of credit, similar to a credit card. For what is known as the draw period (typically 10 years), you can withdraw funds via a special credit card or checkbook up to your limit. It typically takes between two and six weeks to get the initial approval, but some lenders may be faster.

•   With a home improvement personal loan, you receive a lump sum of cash. These tend to be the quickest way to get cash: It may only take a day or so after approval to have the funds available.

How Much Interest Will I Pay?

How much you pay to access funds for your project will vary. Take a closer look:

•   For a home equity loan, you typically get a lower interest rate than some other loan types, since you are using your home equity as collateral. These are typically fixed-rate loans, so you’ll know how much you are paying every month. At the end of 2024, the average rate of a fixed, 15-year home equity loan was 8.49%.

•   For a HELOC, the line of credit will typically have a rate that varies with the prime rate, though some lenders offer fixed-rate options. HELOCs may have lower interest rates than personal and home equity loans, but you will need a high credit score to snag the lowest possible rate.

•   For home improvement loans, which are a kind of personal loan, rates vary widely. Currently, you might find anything from 6.99% to 36% depending on the lender and your qualifications, such as your credit score. These loans are typically fixed rate.

How Long Will I Have to Repay the Funds?

Repayment terms differ among these three options:

•   For home equity loans, you will agree to a term with your lender. Terms typically range from five to 20 years, but 30 years may be available as well.

•   With a HELOC, you usually have a draw period of 10 years, during which you may pay interest only. Then, you may no longer withdraw funds, and move into the principal-plus-interest repayment period, which is often 20 years.

•   With a home improvement personal loan, your repayment terms are typically shorter than with the other options and will vary with the lender. You may find terms of anywhere from one to seven years or possibly longer.

Here’s how these features compare in chart form:

Which Home Improvement Loan Option Is Better?

Now that you’ve learned about the features of these loan options, here’s some guidance on which one is likely to be best for your needs.

When Home Equity Loans Make Sense

Here are some scenarios in which a home equity loan may be a good choice:

•   If you have significant home equity and are looking to borrow a large amount, a home equity loan could be the right move to access a lump sum of cash.

•   If you want to have a long repayment period, the possibility of a 30-year term could be a good fit.

•   When you are seeking to keep costs as low as possible, these loans may offer lower interest rates.

•   A home equity loan can be a wise move when you need cash for other purposes, such as debt consolidation or educational expenses.

•   Some interest payments may be tax-deductible, depending on how you use the funds, which could be a benefit of this kind of loan.

When HELOCs Make Sense

A HELOC may be your best bet in the following situations:

•   You aren’t sure how much money you need and like the flexibility of a line of credit.

•   You want to keep your payments as low as possible in the near future. HELOCs can usually be an interest-only loan during the first 10-year draw period of the arrangement.

•   A HELOC can be a good fit for people who are doing a renovation in stages, and want to draw funds as needed versus all upfront.

•   You need cash for something other than just home renovation, such as to pay down credit card debt or fund tuition.

•   Depending on what you put the money toward, interest payments may be tax-deductible to a degree.

When Home Improvement Personal Loans Make Sense

Consider these upsides:

•   These personal loans tend to have a straightforward, fast application process, and often have fewer fees, such as no origination fees.

•   Home improvement loans are usually approved more quickly than other kinds of home loans.

•   These loans can be a good way to borrow a small sum, such as $3,000 or $5,000 for a project you need to complete quickly (say, a bathroom without a functional shower).

•   Home improvement loans can be a good option for new homeowners, who haven’t yet built up much equity in their home but need funds for renovation.

•   For those who are uncomfortable using their home as collateral, this kind of loan can be a smart move.

The Takeaway

Home improvement is a popular pursuit and can not only make daily life more enjoyable, it can also boost the value of what is likely your biggest asset. If you are ready to take on a renovation (or need to pay off the bills for the reno you already did), you’ll have options in terms of how to access funds.

Depending on your needs and personal situation, you might prefer a home equity loan, a home equity line of credit (HELOC), or a home improvement personal loan. Why not start by looking into a HELOC? A line of credit is a super-flexible way to borrow.

SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.

FAQ

Can a HELOC only be used for repairs or renovations?

You can use the funds you draw from a home equity line of credit (HELOC) for pretty much anything you can think of. But if you are hoping to take advantage of a tax deduction for the interest you pay on your HELOC, it will need to be used to buy, build, or substantially improve a home.

Is a HELOC a second mortgage?

Yes, if you are still paying off the mortgage on your home, a home equity line of credit (HELOC) that is secured by that property would be considered a second mortgage. The same is true of a home equity loan.

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Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

SOHL-Q424-132

Home equity loans, home equity lines of credit (HELOCs), and cash-out refinances are all borrowing options that allow homeowners to access the equity they’ve built in their home. By tapping into home equity — the difference between a home’s current value and the amount still owed on the mortgage — homeowners can secure funds to meet other financial goals, such as making home improvements.

While these three types of loans do have similarities, there also are key differences in how each one works. Understanding the differences in a home equity loan vs. HELOC vs. cash-out refi can help you better determine which option is right for you.

Defining Home Equity Loans, HELOCs, and Cash-Out Refi

To start, it’s important to know the basic definitions of home equity loans, HELOCs, and cash-out refinances.

Home Equity Loan

A home equity loan allows a homeowner to borrow a lump sum that they’ll then repay over a set period of time in regular installments at a fixed interest rate. Generally, lenders will allow homeowners to borrow up to 85% of their home’s equity.

This loan is in addition to the existing mortgage, making it a second mortgage. As such, a borrower usually will make payments on this loan in addition to their monthly mortgage payments. To better understand what kind of payment might be due each month, it is helpful to use a home equity loan calculator.

HELOC

A HELOC is a line of credit secured by the borrower’s home that they can access on an as-needed basis, up to the borrowing limit. The amount of the line of credit is determined by the mortgage lender and based on the amount of equity a homeowner has built, though it can be up to 90% of the equity amount. Like a home equity loan, this is a second mortgage that a borrower assumes alongside their existing home loan.

How HELOCs work is somewhat like a credit card, in that it’s a revolving loan. For example, if a borrower is approved for a $30,000 home equity line of credit, they can access it when they want, for the amount they choose (though there may be a minimum draw requirement). The borrower is only charged interest on and responsible for repaying the amount they borrowed.

Another point that borrowers should keep in mind is that there is a draw period of 5 to 10 years, during which a borrower can access funds, and a repayment period of 10 to 20 years. During the draw period, the monthly payments can be relatively low because the borrower pays interest only. During the repayment period, on the other hand, the payments can increase significantly because both principal and interest have to be paid.

Cash-Out Refinance

A cash-out refinance is a form of mortgage refinancing that allows a borrower to refinance their current mortgage for more than what they currently owe in order to receive extra funds. With a cash-out refinance, the borrower’s current mortgage is replaced by an entirely new loan.

As an example, let’s say a borrower owns a home worth $200,000 and owes $100,000 on their mortgage at a high interest rate. They could refinance at a lower interest rate, while at the same time taking out a larger mortgage. For instance, they could refinance the mortgage at $130,000. In this case, $100,000 would replace the old mortgage, and the borrower would receive the remaining amount of $30,000 in cash.

Recommended: First-time Homebuyer Guide

Home Equity Loans and HELOCs vs. Cash-Out Refi

Here’s a look at how a home equity loan vs. HELOC vs. cash-out refinance stack up when it comes to everything from borrowing limit to interest rate to fees:

Borrowing Limit

With a home equity loan, lenders generally allow you to borrow up to 85% of a home’s equity. HELOCs allow borrowers to tap a similar amount, sometimes as much as 90%. Cash-out refinances, on the other hand, have a slightly lower borrowing limit — up to 80% of a borrower’s equity. The exception is a VA cash-out refi; here it is possible to borrow up to 100% per VA rules, although some lenders may impose a lower ceiling.

Interest Rate

With a home equity line of credit, the interest rate is usually adjustable. This means the interest rate can rise, and if it does, the monthly payment can increase. Home equity loans, meanwhile, generally have a fixed interest rate, meaning the interest rate remains unchanged for the life of the loan. This allows for more predictable monthly payment amounts.

A cash-out refinance can have either a fixed rate or an adjustable rate. Homeowners who opt for an adjustable rate may be able to access more equity overall.

Type of Credit

Both home equity loans and cash-out refinances are installment loans, where you receive a lump sum that you’ll then pay back in regular installments. A HELOC, on the other hand, is a revolving line of credit. This allows borrowers to take out and pay back as much as they need at any given time during the draw period.

Fees

With a home equity loan, HELOC, or cash-out refinance, borrowers may pay closing costs. HELOC closing costs may be lower compared to a home equity loan, though borrowers may incur other costs periodically as well, such as annual fees, charges for inactivity, and early termination fees.

When It Might Make Sense to Borrow

A home equity loan vs. HELOC vs. cash-out refi have varying use cases. With a fixed interest rate, home equity loans can allow for predictable payments. Their lower interest rates can make them an option for borrowers who want to consolidate higher interest debt, such as credit card debt.

HELOCs, meanwhile, provide more flexibility as borrowers can take out only as much as they need, allowing borrowers to continually access funds over a period of time. A cash-out refinance can be a good option for a borrower who wants to receive a large lump sum of money, such as to pay off debt or finance a large home improvement project.

Which Option Is Better?

Like most things in the world of finance, the answer to whether a cash-out refinance vs. HELOC vs. home equity loan is better will depend on a borrower’s financial circumstances and unique needs.

In all cases, borrowers are borrowing against the equity they’ve built in their home, which comes with risks. If a borrower is unable to make payments on their HELOC or cash-out refinance or home equity loan, the consequence could be selling the home or even losing the home to foreclosure.

Scenarios Where Home Equity Loans Are Better

A home equity loan can be the right option in certain scenarios, including when:

•   You want fixed, regular second mortgage payments: A home equity loan generally will have a fixed interest rate, which can be helpful for budgeting as monthly payments will be more predictable. Some may appreciate this regularity for their second monthly mortgage payment.

•   You want to get a lump sum while keeping your existing mortgage intact: Unlike a HELOC, where you draw just as much as you need at any given time, a home equity loan gives you a lump sum all at once. Plus, unlike a cash-out refinance, you aren’t replacing your existing mortgage. That way, if the terms of your current mortgage are favorable, those can remain as is.

Recommended: The Different Types Of Home Equity Loans

Scenarios Where HELOCs Are Better

In the following situations, a HELOC may make sense:

•   You have shorter-term or specific needs: Because HELOCs generally have a variable interest rate, they can be useful for shorter-term needs or for situations where a borrower may want access to funds over a certain period of time, such as when completing a home renovation.

•   You want the option of interest-only payments: During the draw period, HELOC lenders often offer interest-only payment options. This can help keep costs lower until the repayment period, when you’ll need to make interest and principal payments. Plus, you’ll only make payments on the balance used. A HELOC interest-only repayment calculator can help borrowers understand what those monthly payments might be.

Scenarios Where Cash-Out Refi Is Better

Cash-out refinances can make sense in these scenarios:

•   You need a large sum of money: If there’s a need for a large sum of money, or if the funds can be used as a tool to improve your financial situation on the whole, a cash-out refinance can make sense.

•   You can get a lower mortgage rate than you currently have: If refinancing can allow you to secure a lower interest rate than your current mortgage offers, then that could be a better option than taking on a second mortgage, as you would with a home equity loan or HELOC. If interest rates have risen since you first took out your loan, however, a cash-out refi could mean paying more in interest over the life of the loan.

•   You want just one monthly payment: Because a cash-out refinance replaces your existing mortgage, you won’t be adding a second monthly mortgage payment to the mix. This means you’ll have only one monthly payment to stay on top of.

•   You have a lower credit score but still want to tap your home equity: In general, it’s easier to qualify for a cash-out refinance vs. HELOC or home equity loan since it’s replacing your primary mortgage.

The Takeaway

Cash-out refinancing, HELOCs, and home equity loans each have their place in a borrower’s toolbox. All three options give borrowers the ability to turn their home equity into cash, which can make it possible to achieve important goals, consolidate debt, and improve their overall financial situation.

Homeowners interested in tapping into their home equity may consider getting a HELOC or taking a cash-out refinance with SoFi. Qualifying borrowers can secure competitive rates, and Mortgage Loan Officers are available to walk borrowers through the entire process.

FAQ

Can you take out a HELOC and cash-out refi?

If you qualify, it is possible to get both a HELOC and cash-out refinance. Qualified borrowers can use their cash-out refinance to help repay their HELOC.

Is it easier to qualify for a HELOC or cash-out refi?

It is generally easier to qualify for a cash-out refinance. This is because the cash-out refi assumes the place of the primary mortgage, whereas a HELOC is a second mortgage.

Can you borrow more with a HELOC or cash-out refi?

Ultimately, the amount you can borrow with either a cash-out refi or HELOC will depend on how much equity you have in your home. That being said, a HELOC can offer a slightly higher borrowing limit than a cash-out refi, at up to 90% of a home’s equity as opposed to a top limit of 80% for a cash-out refinance.

Are HELOCs or cash-out refi tax deductible?

Interest on your cash-out refinance or HELOC can be tax deductible so long as you use the funds for capital home improvements. This includes projects like remodeling and renovating.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

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Hypothecation may not be a word you’ve heard before, but it describes a transaction you may have participated in. Hypothecation is what happens when a piece of collateral, like a house, is offered in order to secure a loan.

Auto loans and mortgages frequently involve hypothecation, since it allows the lender to repossess the car or house if the borrower is later unable to pay.

There are, though, some more subtle details to understand about hypothecation, particularly if you’re in the market for a home loan. Read on to learn about hypothecation loans.

What Is Hypothecation?

Hypothecation is essentially the fancy word for pledging collateral. If you’re taking out a secured loan — one in which a physical asset can be taken by the lender if you, as the borrower, default — you’re participating in hypothecation. (Hypothecation is also possible in certain investing scenarios. We’ll briefly talk about that later.)

As mentioned above, some of the most common hypothecation loans are auto loans and mortgages. If you’ve ever purchased a car, it’s likely you have (or had) a hypothecation loan, unless you paid the full purchase price in cash.

It’s important to understand that, just because the asset is offered as collateral, it doesn’t mean the owner loses legal possession or ownership rights of it. For instance, with an auto loan, the car is yours even though the lender might hold the title until the loan is paid off.

You also maintain your rights to the positive parts of ownership, such as income generation and appreciation. This is perhaps most obvious in the case of homeownership. Even if you’re paying a mortgage on your property, you still have the right to lease the place out and collect the rental income.

However, the lender has the right to seize the property if you fail to make your mortgage payments. (Which would be a bad day for both you and your renters.)

Why Is Hypothecation Important?

Hypothecation makes it easier to qualify for a loan — particularly a loan for a lot of money — because the collateral makes the transaction less risky for the lender.

For instance, hypothecation is the only way that most people are able to qualify for a mortgage. If those loans weren’t secured with collateral, lenders might have very steep eligibility requirements before they would pay out hundreds of thousands of dollars for a home on a piece of land!

Unsecured loans, however, are possible. A personal loan is a good example.

With an unsecured loan, you’re not at risk of having anything repossessed from you, and you can use the money for just about anything you want.

It’s a trade-off: Unsecured loans are riskier for the lender, so they tend to be harder to qualify for and to carry higher interest rates than secured loans.

On the other hand, if you compare a car loan and personal loan of equal length, you’ll likely be subject to a stricter eligibility screening to get the unsecured loan and pay more interest on it in the end.

Recommended: Smarter Ways to Get a Car Loan

Hypothecation in Investing

Along with hypothecation in the context of a secured loan for a physical asset, like a house or a car, hypothecation also occurs in investing — though usually only if you take on advanced investment techniques.

Hypothecation occurs when investors participate in margin lending: borrowing money from a broker in order to purchase a stock market security (like a share of a company).

This technique can help active, short-term investors buy into securities they might not otherwise be able to afford, which can lead to gains if they hedge their bets right.

But here’s the catch: The other securities in the investor’s portfolio are used as collateral, and can be sold by the broker if the margin purchase ends up being a loss.

TL;DR: Unless you’re a well-studied day trader, buying on margin probably isn’t for you and you should not worry about hypothecation in your investment portfolio. But you’ll want to know it can happen in investing, too.

Recommended: What Is Margin Trading?

Hypothecation in Real Estate

A mortgage is a classic example of a hypothecation loan: The lending institution foots the six-digit (or seven-digit) cost of the home upfront, but retains the right to seize the property if you’re unable to make your mortgage payments.

Hypothecation also occurs with investment property loans. A lender might require additional collateral to lessen the risk of providing a commercial property loan. A borrower might hypothecate their primary home, another piece of property, a boat, a car, or even stocks to secure the loan.

A promissory note details the terms of the arrangement.

Recommended: 31 Ways to Save for a Home

Is Hypothecation in a Mortgage Worth It?

Given the size of most home loans and the risk of losing the home, you may wonder if taking out a mortgage is worth it at all.

Even though any kind of loan involves going into debt and taking on some level of risk, homeownership is still usually seen as a positive financial move. That’s because much of the money you pay into your mortgage each month ends up back in your own pocket in some capacity…as opposed to your landlord’s bank account.

As you pay off a mortgage, you’re slowly building equity in your home. Homes have historically tended to increase in value.

More broadly, homeownership can help build generational wealth in your family.

A Note on Rehypothecation

There is such a thing as rehypothecation, which is what happens when the collateral you offer is in turn offered by the lender in its own negotiations.

But this, as anyone who lived through the 2008 housing crisis knows, can have dire consequences. Remember The Big Short? Rehypothecation was part of the reason the housing market became so fragile and eventually fell apart. It is practiced much less frequently these days.

The Takeaway

Hypothecation simply means that collateral, like a house or a car, is pledged to secure a loan. Mortgages are a classic example of hypothecation, and hypothecation is the reason most of us are able to qualify for such a large loan.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

*Borrow at 12%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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