If you have one or more small home improvement projects that need to be made, you might be considering the pros and cons of using either a Home Equity Line of Credit (typically referred to as a HELOC) or a personal loan. A HELOC and a personal loan are somewhat similar in that either loan leaves the borrower free to use the funds in whatever way they desire.
Compare this to, for example, a home improvement loan. Where a borrower takes out a specific home improvement loan from their bank, the requirement is typically that the borrower specify in detail the improvement to be made, and oftentimes provide the bank with significant documentation, such as site plans, contracts with contractors for the work to be done, and even an updated appraisal.
On the other hand, a HELOC, even though the home is still used as collateral, requires none of that paperwork and does not require the homeowner to identify the specific project or improvement with which the funds will be used. In fact, the funds don’t even have to be used to improve the property – a HELOC is often used in the same way personal loans are, to fund education, travel, or medical procedures.
If you know that you will need funds to make small improvements, but haven’t identified what they are yet, or would have a difficult time providing a lot of specifics to the bank, then you might be best off using a HELOC or personal loan so that you have the flexibility to make small improvements as necessary.
There are both benefits and inherent dangers to using a HELOC. Because secured loans generally enjoy better interest rates than unsecured loans, a HELOC will normally provide a borrower with a better loan rate than a personal loan will. Depending upon the amount that you need to borrow and the length of time you’ll need in which to pay it all back, the rate you can get with a HELOC might save a significant amount of money over the going interest rate for an unsecured personal loan.
But, there’s a reason for that lower rate, and it’s because with a HELOC, as with any loan secured by your home, the lender may be able to foreclose if you fail to make your payments. When a personal loan is used, there is no collateral and no link to the home you’re making improvements to. This means that if you run into tough financial times before the end of the repayment period and stop paying on the personal loan, at least you aren’t in danger of losing your home because of it.
Another important consideration when deciding between a HELOC and a personal loan is the variable interest rates that accompany HELOCs. A personal loan is likely to be lent to you at a fixed interest rate. While that rate might be higher, at least initially, than a HELOC rate offered during the same time period, it is guaranteed to never go up as long as you make your payments on time.
HELOC rates, on the other hand, typically vary from year to year based on a financial index. Your rate will be a certain number of “points” (interest percentages) higher or lower than the index, based upon your credit score. As the index rises and falls, your HELOC interest rate will be recalculated each year and your payment will rise or fall with it. There’s really no way to predict whether it will rise or fall, or by how much, because it depends upon financial market conditions and how they change. If your payments rise dramatically from one year to the next, you may find it difficult not to fall behind, and falling behind can hurt your credit score – or worse, put you in danger of foreclosure.
In short, choosing between a personal loan and a HELOC takes careful consideration of available interest rates, length of the loan, and amount you need to borrow. Smaller home improvement projects might be best funded through small personal loans, offered by companies like Payoff Personal Loans and Marcus Personal Loans, where the interest rate is higher but more predictable. However, if the monthly interest will be significantly lower with a HELOC and the amount is still low enough to be paid off within a short time, the HELOC-associated risk of default and foreclosure can be minimized. The right option will depend upon individual circumstances that take into account all of these factors.
Author: Jeff Gitlen
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