Why Are Most Personal Loans Much Smaller Than Mortgages and Home Equity Loans

When you’re looking into getting a loan, you might find yourself asking, “Why are most personal loans much smaller than mortgages and home equity loans?” It’s a good question and the reason is pretty straightforward. Personal loans don’t usually require collateral like a house or car, making them a bigger risk for lenders. This is why they tend to be for smaller amounts.

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Understanding personal loans

Personal loans are a form of credit that consumers can use for a variety of purposes, from consolidating debt to financing large purchases or covering unexpected expenses. Unlike mortgages or car loans, which are designed for specific uses, personal loans offer flexibility in terms of how the borrowed funds can be used. However, this flexibility comes with considerations for both lenders and borrowers.

Lenders are often more cautious with personal loans because they are typically unsecured. This means they are not backed by collateral, such as a house or a car, that the lender can seize if the borrower fails to repay the loan. The absence of collateral increases the risk for lenders because there is no tangible asset to recover in case of default. To mitigate this risk, lenders may impose higher interest rates compared to secured loans and require borrowers to meet stricter creditworthiness criteria. 

Average amount you can borrow

The average amount you can borrow with a personal loan varies widely based on the lender, your creditworthiness, and other financial factors. Generally, personal loans can range from as low as $1,000 to as high as $100,000. However, the most common maximum loan amounts are between $40,000 and $50,000, with some lenders offering up to $100,000 for well-qualified borrowers, according to Experian. The size of the loan you can access will depend on various factors, including your income, credit score, and debt obligations.

For example, online lenders may offer loan rates ranging from 5.99% to 35.99%, catering to a broad audience from those with excellent credit to those with poorer credit profiles. Banks and credit unions typically have their own ranges, with banks averaging around 12.17% APR for a two-year loan and credit unions offering an average APR of 10.58% on a three-year loan. 

Understanding mortgages and home equity loans 

Mortgages are loans that are specifically used to purchase real estate properties. They are typically secured by the property being purchased, which means that if the borrower fails to make their payments, the lender can take possession of the property through a process called foreclosure.

Mortgages have higher borrowing limits compared to personal loans primarily because they are secured by the property being purchased. This means that the lender has a form of collateral to mitigate their risk, allowing them to offer larger loan amounts. The value of the property serves as security for the lender, reducing the risk associated with lending larger sums of money.

For example, let’s say you want to buy a house worth $300,000. With a mortgage, the lender may be willing to provide a loan of $240,000, which is 80% of the property’s value. This is because the property itself acts as collateral, giving the lender more confidence in offering a higher borrowing limit.

Average amount you can borrow 

For mortgages, the loan amount is largely determined by the home’s purchase price and the buyer’s down payment, creditworthiness, and income. Typically, buyers can finance a home purchase up to the conforming loan limit, which for 2024 is $766,550 in most of the U.S., but higher in certain high-cost areas. 

Home equity loans allow borrowers to tap into up to 80-85% of their home’s value, minus any outstanding mortgage balance. Some lenders might offer up to 100% of the home’s equity, allowing for significant borrowing capacity based on the home’s value and the amount of equity accumulated​.

Factors that influence the sizing of personal loans, mortgages, and home equity loans

Several factors affect how much you can borrow, whether it’s a personal loan, mortgage, or home equity loan. These include the loan’s purpose, your creditworthiness, interest rates, the need for collateral, and associated risk factors.

Loan purpose

Personal loans are versatile, used for anything from debt consolidation to funding major purchases, typically without requiring collateral. This flexibility, however, means generally smaller loan amounts due to the unsecured nature of the loan. 

Mortgages are specifically for buying property, allowing for larger loan amounts since the loan is secured by the home. Similarly, home equity loans are based on the equity in your home, often used for large expenses like renovations, allowing for significant borrowing amounts.

Creditworthiness

Credit requirements vary significantly between loan types. Personal loans can be accessible to individuals with a wide range of credit scores, but those with higher scores are likely to receive larger amounts and better rates. Mortgages and home equity loans typically require higher credit scores for the best rates and higher loan amounts. 

Interest rates

Interest rates for personal loans can indeed vary widely and are generally higher than those for secured loans like mortgages and home equity loans. This reflects the higher risk to lenders for unsecured personal loans. In contrast, mortgages and home equity loans usually offer lower interest rates, as these are secured by real estate, presenting less risk to the lender.

Collateral

Collateral plays a crucial role in determining loan amounts. When collateral isn’t required, as is the case with personal loans, the loan amounts offered are typically smaller. On the other hand, using property as collateral for mortgages and home equity loans reduces lender risk, making it possible to provide larger loan amounts.

Risk factors

Risk factors also influence loan sizing. Personal loans pose a higher risk to lenders, as they are unsecured, generally resulting in smaller loan amounts. Mortgages and home equity loans are less risky for lenders since they are secured by the home, enabling larger loan amounts. The risk of foreclosure, should the borrower fail to make payments, further influences the lending decisions for these secured loans

Risk, reward, and financial strategy

The difference in loan amounts essentially comes down to the risk that lenders take on. Personal loans generally offer smaller amounts, reflecting the higher risk to the lender. This cautious approach is understandable, as no lender wants to face the prospect of losing money. 

However, it’s important to note that while personal loans may not provide as large of amounts, there’s often an option for borrowers to consider alternative financing solutions that align with their needs and financial circumstances.

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