Are you short on cash? Having access to credit/loan can prove extremely helpful at specific points in life, mainly when your bank account is not enough to handle life’s expenses. Getting credit can also be a wise decision when you want to achieve something that would otherwise take years of savings – or you want to have a financial cushion if you ever face a last-minute, unexpected expense. At this point, you may need to decide whether a home equity line of credit or credit cards is the best choice.
Would home equity be better? Or maybe you should just put it all on a credit card?
Home equity is similar to the credit cards in your wallet, but there are vital differences between the two. These differences can help you determine whether a home equity line of credit or a credit card is suitable for your particular situation. Let’s examine each of these options.
Credit cards are open-ended financial tools that allow you to make purchases up to a specific limit without paying for them right away. The money you owe on your credit card should be repaid by a specified date every month, but you can make a minimum payment. The minimum payment is a small per cent of what you owe. Credit cards can help you buy items you wouldn’t be able to afford, but it is primarily a viable option for smaller, daily purchases.
Like a home equity line of credit, you’ll be charged interest only on the portion of the credit amount you use. Instead of opening home equity with your bank, going through the approval process, paying closing costs, you could open a credit card in a few minutes.
Advantages of credit card loans
As it’s with anything, there are specific advantages and disadvantages of borrowing using credit cards. However, these may vary depending on the choice of card you use, your credit score, and how quick you can pay off your debts. If you can settle your debt quickly, using credit can be beneficial in the end. Other advantages include:
- 0% APR introductory period – Many credit cards offers an initial period wherein you’re not charged any interest on anything you spend against the credit card limit. Provided you make the monthly minimum payments, you will not have to pay any interest for 36 months and won’t build up debt on any unpaid balances.
- Rewards – Credit cards usually offer some reward programs. For each dollar you spend, you will get points or rewards in return that you can use for vacation, to buy goods or services, and other perks. Every credit card providers offer something different, so you have to choose one that is in line with your wants and needs.
- Other advantages include:
- Lower credit score requirements
- Does not use your home as collateral
- Could qualify you for discounts, cashback or rewards
- Promotional rates could imply not paying interest at all.
Disadvantages of credit card loans
Credit cards are great financial tools, but if you are irresponsible with money, they can put you deep in debt with every billing cycle that passes. Here are some disadvantages of getting loans with credit cards:
- High-interest rate: Unlike the home equity line of credit, credit cards come with some of the highest interest rates that can continue to increase, leading to thousands of dollars in borrowing costs. The more debt you accrue, the more interest you will have to pay, making paying your debt very difficult with time.
- Limited access to cash – While home equity can give you access to a high credit limit, credit cards usually don’t. It depends on your income and how creditworthy you are. But if you only need a small amount, then a credit card is a better choice.
- Monthly payments – You must be financially sound to make payments on time every month. Otherwise, if you miss any payment or only make minimum payments per month, your debt will rapidly increase, and your credit score will suffer.
- Other additional disadvantages include:
- Credit cards will not qualify you for any form of tax deductions and could result in frivolous spending. It is also not ideal if you need a long pay-off period.
HOME EQUITY LINE OF CREDIT
One alternative to credit cards borrowing is a home equity line of credit. Home equity allows you to borrow a set amount of money against the value of your home from a financial institution. Whether you need funds for a home project, a new kitchen appliance or emergency personal expenses, you can draw a home equity line of credit against your home’s value, helping you meet your financial needs.
Getting a home equity line of credit is a significant financial decision as you will borrow against the equity in your home. Your house is used as collateral for the line of credit, and as you pay back the money drawn, the amount of available credit on your card is refilled – just like a credit card. It means you can borrow again if you need to – whether as little or as much as you need all through your draw period, usually ten years and up to the credit limit you set up at closing.
Home equity can be a good option when you use it to improve the value of your home. But when you use it to pay for things that are otherwise not affordable with your current income and savings, it can become another type of bad debt. An exception to this is in the event of a genuine financial emergency (provided you’ll be able to make the payments). To determine whether a home equity line of credit will be a good option, here are some pros and cons of taking out home equity.
Advantages Of Home Equity Line Of Credit
- No fees for cash draws – Credit cards often charge a fee to draw some cash in advance, and some checking accounts do charge on check-writing. Alternatively, you won’t have to pay a fee to take funds from home equity. Any lender that wants to charge a fee each time you draw money is a good sign to look elsewhere.
- Low-interest rates – Since they are secured debt, the interest rates associated with home equity are generally low, far lower than credit cards. Although the interest rates can fluctuate with time, home equity can give you lower rates than you will get on a standard fixed-rate home equity loan. Home equity line of credits is required by law to have a cap for the interest rate over the loan lifespan, and some even have quarterly limits.
- Tax advantages – Since it is a mortgage type, the interest you pay on a home equity line of credit is tax-deductible for borrowers who itemize. If you file jointly as a couple for a tax deduction, you can get twice of what a single filer can get.
- No restriction on fund use – Unlike other loan types, you can use the funds as you wish when you set up home equity. While you may want to borrow money with a specific plan for the money, once the credit line is set up, you can utilize the funds as it pleases you, without the need for any changes approved by your lender. Of course, you would want to use the fund responsibly since you are backing the loan with your home.
- Pay off when you like – Home equity allows you to pay off the principal when you wish. Consult a loan officer before you close the mortgage, and be sure that there are no fees for early loan repayment. However, note that some home equities may charge a fee if you don’t draw a certain minimum of funds per year or maintain a precise minimum balance.
- No/low closing costs – If you have a good credit score, you won’t need to pay any closing costs required to set up home equity. It implies you may not pay any application fee and no appraisal or closing costs as some lenders may waive them altogether.
- Financial flexibility – Home equity allows you to borrow any amount you need and at the time you need it. You will also only pay interest on what you have borrowed, which makes them helpful in taking care of continuing expenses over some time.
Disadvantages Of Home Equity Line Of Credit
Aside from the fantastic benefits, there are some disadvantages to consider before choosing a home equity line of credit. You can avoid most of these disadvantages with a bit of planning, but you would want to know them beforehand.
- Increased risk of property foreclosure – A home equity line of credit can be a source of lower interest. Still, if you fail to make repayments on your equity, it can increase your risk of foreclosure.
- Dependency on home equity – Another risk with an equity line of credit is the potential to become too dependent on it. Home equity costs little to nothing to establish. The annual fee to have the funds is at most $100. The interest payments are tax-deductible under specific scenarios. Accessing the money is as simple as writing a check. Home equity also makes tens of thousands of dollars readily available to you and spending it feels like making any other purchase. Under these conditions, you can easily rely on home equity to pay for purchases that your monthly income cannot cover. Getting into this habit is dangerous as it eats away your savings and makes it extra difficult to survive if your financial situation changes for the worse. It can also lead to a long-term borrowing period that you had not planned on at first.
- The low-payment temptation – Home equity has a fantastic feature in that, during the draw, your minimum monthly repayment need only cover your interest charges. But if you make only the minimum repayment, you will never pay off any principal, and the loan will never go away.
- Hidden fees – Lenders make money from the interest and annual fees they get on home equity. They lose money if you refinance or cancel a home equity loan before the draw period ends. While many of them will charge an early termination fee, some may charge extra fees if you fail to borrow a certain amount each year or you do not maintain a minimum loan balance. Before you draw the loan, check out for hidden fees and ensure you know when you can incur additional charges or fees- and how much.
- Variability in interest rates- Home equity has adjustable rates. The interest rates on home equity are low when you start out but can rise quickly if inflation sets in. When that starts to happen, most equity line of credits will give you the option to convert your loan balance to a fixed-rate loan. Fixed-rate loans are priced higher to account for the risk that interest rates may increase. When the interest rate increases, it also means you could end up paying a higher rate than you started with.
- Losing home value – Taking a home equity loan may decrease the value of your home, eliminating the remaining equity you have. This, in particular, can be an issue if you plan on selling your home or refinancing to cover the loan. In some instances, you could end up submerged on your home loans, owing more on your home equity and mortgage combined – than your home is worth.
COMPARING HOME EQUITY AND A CREDIT CARD
One big issue with debts or loans is the interest rate. The higher the interest rate, the quicker it can build up – and the more difficult it would be to pay off. To compare the interest rate on your credit card with interest you’d pay on home equity to find out what works out best for you. You are almost surely going to get a lower rate on home equity but think about the repayment timeline as well.
On the other hand, while a credit card may have higher interest rates ranging from about 14% to 25%, you may ultimately save money if you’re able to pay it off within a year. Furthermore, the interest rates on home equity are connected to the prime lending rate. It implies they can change with time. Due to the variability, they contain the risk of rates going up, making payments challenging to meet.
Whilst home equity is secured, drawing out a loan from credit cards is not. Home equity may not work for you if you don’t have much equity in your home or don’t own a home. But credit cards may be a better alternative based on your financial circumstances. Furthermore, home equity deduction does not apply to every situation. Suppose the interest deductions on home equity are not beneficial to you, probably because you have attained the maximum mortgage limit. In that case, you can consider a credit card that features a very low or zero per cent interest – or some rewards. Credit cards are open-ended credit lines that don’t have a draw or repayment periods. Most of them have annual fees. Home equity lines of credit have both the draw period and the repayment period and are a bit like mortgages in that they have closing costs.
WHEN TO USE A HOME EQUITY OR A CREDIT CARD
While credit cards and home equity work similarly, it can be a daunting task to decide when either one is the best option. This, in particular, may be the case if you can merge credit card debt with home equity or pay off home equity with credit cards.
I will suggest using home equity when it is tax-advantageous to do so and for certain personal purchases or expenses, but you have to be careful. I will suggest you use credit cards to pay home equity if you have confidence in your finances or need funds quickly.
Both home equity lines of credit and credit cards offer a flexible way to borrow money. As with any financial tool, it’s wise to compare the fees, interest rates, and repayment terms of any agreement to ensure you make the best decision. No matter the option you choose, make sure you apply for the right one for you. And do not forget that employing the services of a financial adviser could also be helpful. Send All Request & Donations To: 2288 Gunbarrel Rd. Suite 154/388, Chattanooga/TN 3742.
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