8/4/2016 | By Team United
When it comes to financing options, homeowners have a certain advantage over non-homeowners because they can borrow against the equity in their homes. And home equity loans can be used for more purposes than you might think; they’re not just for improvements and renovations. So why would you choose a home equity loan over other types of personal loans or vice versa?
When deciding the best loan for your financing need, you should first understand the differences between your options. There are two basic types of loans: secured and unsecured. According to NerdWallet, “A secured loan is backed by an asset that the lender can seize if the loan is not repaid, typically a car or a house. An unsecured loan is granted based on your creditworthiness alone.”
Auto loans (backed by the car you’re purchasing) and mortgages (backed by your property) are common examples of secured loans. Home equity loans and lines of credit also fall into this category, as they are backed by your home. An unsecured loan, on the other hand, is not tied to any collateral. Instead, the lender will evaluate your creditworthiness solely based on factors like your credit score and your debt to income ratio. Personal loans are typically unsecured loans, although there are other options such as savings secured loans, which borrow against a savings account or CD balance.
Generally, secured loans have lower interest rates than unsecured loans, because they are less risky to the lender. If you fail to make payments, they can repossess the car or foreclose on the property to recoup some of their loss.
Now that we’ve covered the differences, let’s look at what you should keep in mind when deciding how to finance various borrowing needs.
We’d be remiss not to mention this common use for home equity loans and lines of credit. Borrowing against your home for renovations makes sense, given the value you can expect to add to your home. If you’re considering a remodel, you’ll want to check out CNBC’s list of projects that add the most and least value to a home.
A home equity line of credit (HELOC) is typically recommended during a home remodel because you can periodically withdraw cash to pay contractors as materials are ordered and work is completed. As a revolving line of credit, HELOCs have no set number of payments, and you can borrow as little or as much as you need at a time, up to your established credit limit. You get the flexibility of having access to cash, but don’t pay interest until you withdraw it. Another perk to a HELOC? The interest is usually tax deductible for loan amounts up to $100,000, according to myFICO.
When borrowing money for a one-time large purchase—like a vacation or a wedding—a home equity loan or line of credit is likely to offer you the lowest rate. You can choose a HELOC if you prefer to withdraw just what you need to cover expenses as they come due or opt for a home equity loan if you would rather budget for consistent payments over a pre-determined period of time. Choosing a HELOC through United Federal Credit Union also gives you the additional convenience of accessing funds on-the-go with a Visa® access card. As you compare loan rates, be sure to ask your lender about any closing costs, prepayment penalties or other fees that can quickly add up. UFCU home equity loans and lines of credit do not charge closing costs, origination fees or annual fees.
Of course, both of these are only an option if you have enough equity in your home to borrow against. If you aren’t a homeowner or simply prefer not to use your home as collateral, a personal loan is another option. Though an unsecured loan comes with a higher interest rate than a home equity loan, you’re likely to get a lower rate than if you simply put the purchase on your credit card.
With auto loan rates as low as they have been in recent years, this is one situation where we wouldn’t typically recommend turning to a home equity loan. This is especially true when you consider that your average car depreciates in value. Plus, when you choose an auto loan, you have the option of adding on GAP coverage, extended warranties and debt protection to help cover some of the larger expenses of car ownership.
That said, it’s always wise to run the numbers, compare interest rates and evaluate what maintenance costs and other vehicle expenses you would be prepared to cover with savings. Use our loan calculators to explore your financing options.
Because of their generally lower interest rates, home equity loans can be attractive options for debt consolidation, depending on what types of loans you are looking to consolidate. Their longer repayment periods can help reduce your monthly payment (though that may also mean you pay more in interest over the life of the loan).
In exchange for the better interest rate, you are putting your home to work as collateral, so you’ll want to fully evaluate your budget to make sure you can comfortably make the new payments. In addition, certain loan types have benefits of their own, like the student loan interest tax deduction, that you can lose out on by consolidating. We recommend first consulting with a financial counselor and your tax advisor for advice specific to your financial goals. UFCU makes experienced counselors available to our members at no cost through our Member’s Assistance Program.
Whatever your financing needs, UFCU loan officers are available to help you evaluate your options, including home equity loans and lines of credit. Click here for current rates and check out our loan calculators to start planning your budget.
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