HELOC vs. credit card: which is the better choice?
HELOCs and credit cards are both types of revolving credit. Revolving credit is a line of credit that you can borrow from, repay, and borrow from again, as the credit line is replenished by your payments. Ideally, this keeps the credit available and "revolving" so it's there when you need it.
Credit cards are given based on your credit score and are not secured by collateral, whereas HELOCs are given based largely on the equity in your home and are secured by your home.
Credit cards are ideal for everyday purchases and when you can pay off the balance each month. Credit card interest rates are higher than HELOC rates, which makes carrying large credit card balances a financial burden. HELOCs are better when a large sum of money is needed, and the balance is repaid with interest-only during the draw period. This makes HELOC debt more manageable and potentially less costly than credit card debt.
Read on to learn more about HELOCs vs. credit cards.
At Credit Union of Southern California (CU SoCal), we make getting a Home Equity Line of Credit (HELOC) easy.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all your banking needs.
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What is a HELOC?
A
Home Equity Line of Credit (HELOC) is a type of “revolving” credit that is provided by a lender which has a credit limit, a variable interest rate, and which is secured by the equity in your home. Most HELOCs have a 10-year “draw period” during which money can be borrowed, followed by a repayment period.
There are
HELOC pros and cons to consider. One of the advantages of a HELOC is that you can take out money as you need it, and you will only pay interest on the amount you use.
What is a credit card?
Credit cards allow you to borrow money from the card provider (up to a limit) to make purchases and even withdraw cash in the form of a cash advance. When you use a credit card, the amount you spend is automatically added to your outstanding balance. As you pay your monthly bill your available credit is replenished by the amount you repay.
Credit cards come with high interest rates. This rate will be applied to any outstanding balance that you do not pay off. This is the primary reason why it's important to pay your credit card balances in full each month. If you carry a balance from month-to-month you could pay hundreds or thousands of dollars in interest.
Because each credit card holder will be given a specific credit limit, any transaction that exceeds your limit automatically be declined.
Purchases made using your credit card are subject to an Annual Percentage Rate (APR). The APR varies from the cardholder to cardholder depending on factors like your credit score, which is why it’s so important to have a good score.
How do HELOCs vs. credit cards compare?
Eligibility requirements
Credit Cards. Requires a good credit score, as determined by the credit card issuing bank or company.
HELOCs. Requires sufficient equity in your home, plus good credit.
Interest rate
Credit Cards. May start with a 0% APR, then increase to a higher rate.
HELOCs. Starts with a variable rate during the draw period, then readjusts to a fixed rate for the repayment period.
Collateral
Credit Cards. No collateral is required to get a credit card.
HELOCs. Requires your home be used as collateral to secure the loan.
Impact to credit score
Credit Cards. Failure to pay your bill can cause your credit score to decline.
HELOCs. Failure to repay the loan can cause your credit score to decline and lead to foreclosure on your home.
Access to funds
Credit Cards. If you haven't reached your credit limit, you can continue to make new purchases.
HELOCs. If you haven't reached your credit limit, you can continue to make new purchases during the draw period.
Repayments
Credit Cards. A bill is sent monthly, and you must make a minimum payment. Carrying a balance is allowed, up to your credit limit.
HELOCs.
Repayment is paid monthly and includes interest-only during the loan's draw period. When the draw period ends you must pay interest and start repaying the principal (the amount you've borrowed).
Fees
Credit Cards. Common credit card fees include a late payment fee and an annual fee for some cards.
HELOCs. Common HELOC fees include a prepayment penalty fee and an inactivity fee if you don't use your line of credit.
Tax advantages
Credit Cards. No tax advantages.
HELOCs. Interest paid on home equity loans and lines of credit are deductible if the borrowed funds are used to substantially improve the taxpayer’s home that secures the loan.
Term
Credit Cards. Credit cards have no limit on the number of years your account is open.
HELOCs. HELOCs have an end date when the loan must be repaid.
Pros and cons of HELOCs
There are several
HELOC pros and cons to be aware of:
Pros
Access to funds. Once you're approved for a HELOC you'll likely have a 10-year draw period during which you can use your money any way you choose.
Higher borrowing limit. Qualified borrowers with ample home equity may be able to get approved for amounts up to $1,000,000. This is a significantly higher loan limit than personal loans or credit cards provide.
Lower interest rates. HELOCs start with a low variable interest rate that typically stays in effect for a 10-year draw period, during which you can withdraw from your line of credit. The interest rate on a HELOC may be lower than interest charged on credit card purchases and personal loans.
Fixed-rate options. Typically, a HELOC comes with a variable interest rate, which means that the interest charged is based on a financial index that varies. As the financial index moves up and down based on economic factors, the interest rate charged to the borrower will fluctuate. Some lenders are starting to offer a fixed interest rate option during the loan draw period, so be sure to ask about variable vs.
fixed interest rate HELOCs.
Tax advantage. According to the
IRS, interest on home equity loans and lines of credit are deductible if the borrowed funds are used to substantially improve the taxpayer’s home that secures the loan.
Cons
Variable interest rates may rise. Depending on economic factors, a variable rate loan may be beneficial and result in paying less interest. Conversely, you could end up paying more interest if the index tied to the interest rate rises.
Overspending. Having easy access to money makes it tempting to overspend or spend the money on luxury purchases that aren’t necessary. Be sure to use your HELOC for your original intended purpose.
Minimum draw requirements. Some lenders require you to take a minimum draw each time you access your line of credit (for example, $5,000) or withdraw a certain minimum amount the first time you use your loan.
Risk of foreclosure and damaged credit. If you fail to repay the loan, make late payments, or are unable to make your first mortgage payments, these events will be reported to the credit bureaus and your credit score will drop. Because a HELOC is secured by the equity in your home, defaulting can result in the lender foreclosing on your home.
Pros and cons of credit cards
While credit cards are very convenient and the go-to form of payment for most consumers, there are downsides to credit cards. Here are some credit card pros and cons to consider.
Pros:
Introductory interest rates. It's easy to find credit cards with special introductory rates that may be as low as 0% APR (Annual Percentage Rate).
Promotional fee-waiver. Many credit cards offer 0% interest on balance transfers, encouraging consumers to transfer high balances, which saves money on interest until the promotion expires.
Builds credit. Credit cards can help you build credit, so long as you don’t have too many cards or overspend.
Convenient. Credit cards are the easiest form of payment today, allowing instant point-of-purchase transactions, online purchases, and purchasing power around the world.
Cons:
Risk of overspending. The convenience of credit cards combined with generous credit limits makes it easy for people to overspend.
Some credit unions and banks may charge an annual fee for credit cards, particularly cards that come with rewards or points.
High adjusted interest rates. After the introductory period ends, most credit card rates adjust significantly higher, meaning your 0% APR card could jump to 16% or higher charged on any unpaid balance.
Late payment and missed payment penalties. Credit card companies often charge late payment fees, and if you make too many late payments your interest rate will be increased.
Credit score damage. According to the credit bureau Equifax, having multiple credit cards can indirectly impact your credit scores by lowering your debt to credit ratio — also known as your credit utilization rate. Your credit utilization rate is the amount of credit you use compared to the total credit available to you.
When to choose a HELOC over a credit card
There are situations when using a HELOC to pay for expenses might make more sense than using a credit card. Here are some examples of when to choose a HELOC:
The interest rate is lower. HELOCs start with a low variable interest rate that may be lower than interest charged on credit card purchases and personal loans.
You need to borrow a large sum. Qualified borrowers with ample home equity may be able to get approved for amounts up to $1,000,000.
You want tax benefits. Interest paid on home equity loans and lines of credit are deductible if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan.
When to choose a credit card over a HELOC
You don't have enough equity. If you haven't owned your home for long you may not have enough equity to be approved for a HELOC.
You don't want to carry a balance. It may be easier to pay off a credit card than it is to pay off a HELOC, because HELOCs have prepayment penalties.
You want to take advantage of a promotion. 0% introductory interest rates are common.
You need money fast. For making on-the-spot purchases, credit cards are more convenient than a HELOC, which can take up to six weeks to approve.
You don't want to use your home as collateral. HELOCs require your home to be used as collateral, which means that failure to repay the loan can result in your home being taken by the bank. Failure to repay credit card debt is serious and can ruin your credit score, but it is unlikely that a credit card company will attempt to foreclose on your home.
Other borrowing options to consider
If credit cards or a HELOC doesn't work for your situation, consider one of these other borrowing options:
Home equity loans. A home equity loan differs from a HELOC in how the funds are disbursed and the interest rate. A home equity loan provides funds in a lump sum and the interest rate is fixed. With a home equity loan, monthly loan payments will include both principal and interest, whether you use the funds or not.
Personal loans. A personal loan can be used to pay off debt and bills, make home renovations, pay for a wedding, or any other expenses you have. Can you use a personal loan to buy a house? Technically, you can, but a personal loan isn’t a great option for purchasing a home or making a down payment in most cases. Instead, you’ll generally be much better off with a traditional mortgage.
Cash-out refinance. Cash-out refinancing is when a homeowner refinances their mortgage to a new mortgage (typically at a lower interest), and in the process, borrows more money than what is needed to pay off the current mortgage. The first mortgage is paid off and the homeowner gets a lump-sum payout of the extra cash amount at closing.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!