As its name implies, a HELOC or Home Equity Line of Credit essentially differs from the other forms of home loans, in that instead of receiving a lump sum upon loan approval, the borrower gets a revolving credit line which he can draw on should the need arise.
In that respect, it works in the same way as a credit card does, and you only pay for the portion of that credit line you use. That is where the similarity ends though, as HELOCs and credit cards also differ in many other ways.
So, which line of credit should you keep on standby for that occasional home project and other out-of-the-budget expenses? This HELOC vs. credit card comparison discusses the factors to consider before taking out either of them. Let’s start with the basic features:
Compare Features of HELOC vs. Credit Cards
|Payment Period||5-20 years||Less than 5 years|
|Payment Terms||Flexible||Minimum Amount Required|
|Fees||Application/Closing Fees, Annual Fees||Annual Fees plus Other Types of Charges|
Secured Vs Unsecured Debt
There are both advantages and disadvantages on taking out a secured type of credit. With a HELOC, if you have sufficient equity on your home, you can apply for a sizable amount, and it will likely be granted for as long as you can establish that you have the means to pay it back.
On the other hand, most credit card issuers are slashing credit lines of consumers in anticipation of the rising card defaults. Even those who have excellent credit scores and a clean payment history have been subjected to such measures. So while you don’t need any collateral to avail of a credit card, it’s unlikely that you will be given or be allowed to maintain a high credit limit.
But when evaluating the HELOC vs credit card in terms of the need for collateral, it’s worth taking the time to study what the consequences will be if you fail to meet your loan obligations. A credit card default can put a serious dent on your credit score and can lead to debt settlement or bankruptcy filing. These options however, are much better than having your home taken from you – which is the worst case scenario with a HELOC.
The Lower Interest Rate Option
The interest rates for both the HELOC and credit card are variable. The former adjusts with changes in the prime rate which typically changes monthly, while the latter is dependent on a lot of factors, some of which are beyond the cardholder’s control – the credit score, payment history, or even just the bank’s or issuer’s decision to raise interest rates.
Currently, HELOC interest rates are within the 5% – 6% range while the average rate for credit cards is around 12%. If your purpose is to pay-off a high-interest debt, there are still a handful of credit cards that offer very low Balance Transfer Rates – even lower than HELOC – but you would need to have excellent credit history for this, and if you use the card for regular purchases, that’s where you could get slapped with sky-high rates.
Payment Period and Terms
As with any home loan, the payment period for a HELOC can stretch to as long as 10 to 20 years, with the added option to pay the interest only on some months. With a credit card, the validity period would usually be between 2 to 4 years only, although you do have the option to renew it for as long the bank allows you to. The minimum amount required every due date comprises of both the interest charged for that particular period and a portion of the principal amount.
A HELOC could cost more upfront because there are lenders that charge application, appraisal, and processing fees. After the initial costs, however, the fees are pretty straightforward, such as an annual fee, and depending on the lender, a non-usage fee, which is applied if the HELOC remains unused for a time.
In contrast, credit card companies rarely let you pay significant costs upon applying or approval of a card, and in most cases, annual fees, amounting to about $50 to $100, are waived on the first year. Aside from annual fees though, there’s also a whole lot of other fees to contend with where applicable, such as balance transfer or cash advance fees, finance charges, late payment, and over limit fees.
In summing up all the factors involved in both alternatives, these stand out clearly: HELOCs allow larger loan amounts, charge lower interest rates, and have longer payment terms. The choice between getting a HELOC or a credit card however, would boil down to whether or not you are willing to take the risk of having a foreclosure on your hands in the future.