Is Home Equity Financing Cheaper Than a Credit Card or a Personal Loan?

In today’s high interest rate environment, finding the best financing options when you need a loan will save you money. While credit cards and personal loans are the most accessible forms of credit, both tend to have high interest rates which may cost you more in the long run. If you are a homeowner with equity in your property, you could consider home equity financing as an alternative. In this blog, we’ll discuss why home equity financing may be a less expensive alternative to borrowing than using a credit card or personal loan.

Current Interest Rate Trends

Interest rates on loans have increased significantly since early 2023 and have remained high. According to Bankrate.com, the cause for the high rates is due to increases in the federal funds rate to combat rising inflation.

Today, these rates make it more costly to borrow. The average rate for personal loans is at 12% while home equity loans are at 9%. Credit cards usually have the highest interest rates, with an average rate of 24% in July 2024, according to BusinessInsider.com.

There is optimism that rates will drop within the next two years once the Federal Reserve decides that inflation has slowed. If you’re exploring borrowing options, it’s smart to shop for the best rate possible first.

When To Use Home Equity Financing

Home equity financing can help pay for a variety of things. You can use it to pay for home improvement projects, such as energy-efficient upgrades, or for college tuition, a wedding or any other major expense.

What makes home equity financing unique is that you are borrowing from the existing equity in your home, minus your mortgage balance. For example, if your property is valued at $600,000 and you have a $300,000 balance on your mortgage, then you have $300,000 in home equity. In most cases, you can borrow up to 85% of the home’s combined loan-to-value ratio.

Applying for a home equity loan requires you to own your home and have good credit and a steady income, according to RocketMortgage. You can apply to a credit union or bank, both of which will require a home appraisal by an independent appraiser to determine your property’s value, which sets the amount of equity available to borrow against.

If approved, the home equity loan is considered a second mortgage with a lien on your home. There are two types of home equity loans:

• Home Equity Loan: A home equity loan is a fixed-rate loan that has a specific borrowing term. You’ll decide how much to borrow and then pay back that amount, plus interest, over a set period, such as 5 or 10 years. The interest rate remains the same throughout the life of the loan. This is a good option if you want fixed monthly payments without worrying that your interest rate may rise.
• Home Equity Line of Credit (HELOC): As its name implies, a HELOC is a line of credit that taps into your equity for a specific period, such as 10 years. During this time, you can borrow money from your line of credit at a variable interest rate and make monthly payments just on the interest owed. Once this draw period is over, your HELOC will turn into a fixed-rate equity loan and you’ll pay both principal and interest over that repayment period, which is usually 15 years. HELOCs are a good option if you want the ability to access equity financing but don’t need all the funds right away. Plus, the option to make interest-only monthly payments gives you financial flexibility. Your interest rate will vary during the draw period, which may cause your interest-only payments to change each month.

Rates on home equity loans and HELOCs tend to be lower than credit cards or personal loans, making them a smart alternative that can save you money.

When To Use Personal Loans or Credit Cards

Personal loans and credit cards can be efficient ways to borrow money if you are looking to access quick financing and don’t want to wait for an appraisal and other processing that comes with applying for home equity loans or lines of credit. Personal loans and credit cards do not require collateral, and at some lenders you can get financing on the next business day, according to Bankrate.com.

Because there is no collateral on either of these loan products, interest rates are higher compared to home equity lending. Here are some other things to know about personal loans and credit cards.

• Personal Loans, which are sometimes referred to as signature loans, let you borrow a lump sum of money based on your credit alone. You’ll pay back the loan over a fixed number of months and at a fixed interest rate. Your payments include both principal and interest, and there are usually no fees if you pay off the loan early. The loan is considered closed once it is paid off, meaning you can’t withdraw from it again.
• Credit Cards are a revolving line of credit that you can withdraw from as long as your account remains in good standing. When you’re approved for a credit card, you’ll be given a credit limit, which is the total amount available to borrow. You’ll also be assigned a variable interest rate based on your credit score and credit history. Each month, you can make the minimum payment due, pay more or pay off the entire balance. Some credit cards offer introductory interest rates and/or rewards programs that give you points you can redeem for cash, merchandise or travel. Because of the variable (and higher) interest rate, it may take you longer to pay down or pay off your existing balance versus other loan products. Also, any late or missed payments may lower your credit score. You may also face late payment fees depending on the card issuer. Some credit cards also have an annual fee. It is best to shop around with financial institutions to find the card with the lowest interest rate, best benefits and features that fit your unique financial situation.

Your financial wellness depends on making the right decisions about money, so if you own a home, try looking into home equity financing first.

TCU Can Help You

Travis Credit Union is your resource for home equity financing, personal loans and credit cards. As your local lender with more than 70 years of experience, TCU has the knowledge, products and financial strength to help get the right loan for you. You can apply online at traviscu.org. If you are interested in a first mortgage or business loan, we can help, too.