Personal Loan vs Home Loan: Which offers a better deal? 

When financing a renovation or buying a big-ticket item, some homeowners use their home loan to access the money they need. Others finance their project by taking out a personal loan instead. So which option is the best choice to help you reach your goals?

While most Austrlaians may be able to apply for a personal loan to pay for a project or major purchase, home owners may also have other options to consider, such as:

• Refinancing the home loan and borrowing extra cash
• Redrawing extra repayments they’d previously made onto the loan
• Taking out a home equity loan or a line of credit secured by the value of the equity in the property. 

However, sometimes applying for a separate personal loan could be a simpler and/or more financially sound decision than accessing the equity in a home. Consider the following factors before making your decision:

The interest rate

The amount of interest you’ll pay on your loan is often the main factor people consider when choosing a loan. The higher a loan’s interest rate, the more you may be charged for borrowing money.

Home loans generally offer lower interest rates than personal loans, so refinancing or redrawing a home loan could cost you less in interest charges each month than taking out a separate personal loan.

However, it’s also important to consider the following point:

How long you wish to be in debt

When you borrow extra on your home loan to pay for a project, you’ll be repaying this extra debt over your remaining loan term, which could be between 20 and 30 years. This could mean that even with a lower interest rate, you may still pay more in total interest over time for funding your project.

Using a personal loan could let you pay off your renovation in somewhere between 1 and 7 years. The shorter your loan term, the more your repayments will cost each month, but the less interest you’ll be charged in total over the long term.

How you wish to secure your loan

Depending on your financial situation, increasing your home loan to help pay for a project could put you at a higher risk of defaulting on your repayments. This in turn could lead to you losing your home.

A personal loan can be secured against another asset than your property, such as a vehicle, savings in a term deposit, or even valuable artworks or jewellery. You can also choose an unsecured loan that means you don’t risk losing your security, though you’ll likely be charged a higher rate of interest.

Fees

Both home loans and personal loans could involve paying fees as well as interest charges, which could affect your overall budget. These fees could include:

• Ongoing fees: May be paid monthly or annually
• Application fees: A one-off charge when you first apply for a loan
• Early repayment costs: If you make extra repayments and repay a loan ahead of schedule, in some cases the lender may charge you a fee.

Example

Imagine you have a home loan of $500,000 to be paid off in monthly principal and interest instalments at a rate of 4% over the next 25 years.   

Now imagine you need to borrow $10,000 to renovate the floors in your property. You find a personal loan with an 8% interest rate that could be paid back over a term of 3 years.

Here’s how the costs could potentially add up:

Source: RateCity Home Loan Calculator, RateCity Personal Loan Calculator

This example is for illustrative purposes only and does not account for fees or changes to variable interest rates over time.

Increasing your home loan by an extra $10,000 (such as redrawing previous extra repayments or refinancing to borrow more) would only cost you an extra $53 a month, compared to $313 per month by taking out a separate personal loan. However, over the 25-year term these extra costs would slowly but surely add up, costing you an additional $4555 in total compared to the combined cost of the original loan plus the 3-year personal loan ($803,035).

Of course, making extra repayments onto your home loan or your personal loan could help you pay off the extra debt sooner, potentially reducing the total interest you’d pay. Additionally, renovating your property could potentially help to increase its value, which could allow you to acess more equity in the property in the future.

Before making any of your own financial decisions, it’s important to make your own calculations to work out the best course of action to suit your financial situation and personal goals. Consider contracting a financial adviser or a mortgage broker for more advice on the best choices for your personal situation.

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