Three Alternatives to Home Equity Loans
Home equity loans are a popular option for borrowing money. Rates are attractive, the interest paid is often tax-deductible and options such as a home equity line of credit (HELOC) provide financial flexibility.
But there are situations where a home equity loan may not be the right choice, or you may not be able to qualify. Here are three alternatives to home equity loans that you might consider.
Cash-out refinancing
A cash-out refinance is another way of borrowing against your home equity. Instead of taking out a separate home equity loan, you refinance your mortgage and take money out of the transaction, so the loan amount is rolled into your new mortgage balance.
A cash-out refinance offers a lower interest rate than a standard home equity loan, but has much higher closing costs, since you're refinancing the entire mortgage. For that reason, it works best if you have to borrow a large amount of money or can lower your overall mortgage rate in the process. Or both.
A cash-out refinance also gives you the convenience of having only a single loan payment per month, rather than separate payments for a mortgage and home equity loan.
Rethinking credit card cash advances
Financial advisers often warn against taking a cash advance on a credit card. Yes, they're a simple and fast way to get money and the short-term 0 percent rates many lenders offer can be tempting. But they're also an easy way to get trapped into high-interest debt after the introductory rate expires – interest rates on many cash advances shoot up to 18-24 percent plus after only six to 12 months.
A credit card cash advance can be useful if you don't need a large amount of money and are confident you can pay it back fairly quickly, before those high interest rates kick in. Be sure to read the fine print before proceeding – some cash advances have been known to retroactively charge the full interest rate on the entire cash advance if the full balance isn't paid off by the end of the introductory period.
With a cash advance or other unsecured loans, you're not putting up your home as collateral That means you don't have to worry about losing it to foreclosure if you fail to keep up your payments, as can happen with a home equity loan or cash-out refinance.
Getting personal - loans
A third option is a personal loan from a bank. People often overlook these, but they're a standard loan option offered by most lenders, along with other loan products like auto loans, business loans, student loans, home loans, etc.
Personal loans come in two types: Unsecured and secured. An unsecured is when a lender simply lends you the money based on your credit and financial standing, and you repay it over a predetermined schedule. It's like a one-time credit card, without a piece of plastic.
Interest rates are considerably higher than on a home equity loan but are usually lower than the post-introductory rate on a credit card cash advance. The interest you pay is usually not tax-deductible, unless you use the money for certain types of home improvements or other allowed uses.
A secured personal loan is when you put up something as collateral to back the loan. This may be a financial product such as stocks or a certificate of deposit, or a tangible asset like a boat or a car. Because the loan is secured, you can get a significantly lower rate than you can on an unsecured loan. However, if you fail to repay the loan on time you could lose your collateral – but at least it won't be your home.
As with an unsecured personal loan, the interest you pay is not tax-deductible unless the money is used for allowed purposes such as certain home improvements.
Home equity loans and lines of credit have a lot to recommend them, but as a homeowner you have other options as well. Choose the one that works best for your situation.
(Updated August 2017)
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