Essentials of Borrowing
Credit Cards versus Home Equity Loans
If you own your home and pay a mortgage, you probably already know that there are certain income tax advantages for deductions such as interest payments made each month. And if you use a credit card, you know that there are no such perks available, even though credit card borrowing usually means paying much higher rates of interest, fees, and penalties. For some circumstances, especially when attractive interest rates are offered, the credit card can be a superior choice. If you happen to be one of the rare consumers who can manage credit card debt by paying it off every month and not incurring fees, don’t forget to factor the credit card loan option into your decision. But overall, using home equity loans to borrow money makes more sense than racking up credit card debt, and although there are a few special exceptions, most financial counselors will encourage homeowners to tap equity for loans, rather than using the plastic in their purses and wallets. There are essentially two different ways to borrow with equity, and those are the home equity loan, and the home equity line of credit, or HELOC.
A HELOC works much like a credit card, except that you can usually pay it off over a much longer period of time, and you can borrow more, as long as you have the home equity to back up your line of credit. And interest paid on HELOC loans is similar to credit card interest, because it is normally not tax deductible, and the rate paid is higher than most mortgage rates. You access the funds when you need them, by using convenient checks or credit card type instruments provided by the lender. HELOC loans are a good choice for those who want to borrow easily, with very few closing costs, and who want to borrow at their own pace, without using credit cards, and are handy for purchases or other outlays of cash that are relatively small. The common home equity loan – also known as a 2nd mortgage – is somewhat more complicated to apply for, but it has its own rewards.
Unlike a HELOC, the typical home equity loan requires closing costs and fees related to originating the loan. So for a short-term loan, it may not be the less expensive option. For longer periods of borrowing, or for larger amounts that will incur substantially more interest, however, it is a great option. And many of the closing costs, plus the monthly interest payments, will be tax deductible for most homeowners. These home equity loans or 2nd mortgages come with lower interest rates, which is a big advantage. One or two points of interest can cost hundreds or thousands of dollars over a period of years. And whereas a HELOC will normally be an adjustable rate loan – meaning that your payments might increase if interest rates keep going up – you can acquire a home equity loan with a fixed rate, and keep that rate for the entire life of the loan. Weigh the pros and cons of each, and then choose the alternative that is best for you.
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