Which is best: Home equity line of credit or a credit card?

HELOCs are second mortgages

By Queenie Bates

If you need some extra buying power but don’t actually want to take out a lump sum loan, you are possibly considering buying on credit. In which case, you might want to know whether a credit card or home equity line of credit (or HELOC, pronounced “hee-lock”) would suit you best. Or, perhaps you have a credit card, but should be considering another alternative with HELOC.

What is home equity line of credit?

 

A home equity line of credit is similar to a home equity loan, in that it is cash borrowed against the equity of your property, with your property used as collateral. Home equity, sometimes called real property value, is the difference between the home's fair market value and the outstanding balance of all liens on the property.

However, with a home equity loan you would borrow a lump sum, similar to taking out a personal loan, which would need to be paid back in full before you could borrow cash again. On the other hand, a HELOC works similar to a credit card, in that you use a line of credit to borrow sums that total no more than the credit limit.

As you make payments against the mortgage balance (or as the market value appreciates), the property's equity increases. The higher your home equity value is, the higher your maximum credit limit can be.

The pros

The drawcard for HELOC is that like home equity loans, they usually entail easier repayment terms than other loan options, because they offer lower interest rates and a longer term to repay them over. This is also why it is often used as a debt consolidation option. Further, the interest paid on HELOC is generally tax deductible, unlike that paid on credit cards.

Many lenders also choose HELOC because they have a better connotation than a "second mortgage," which is often associated with an unpleasant level of debt. Ironically though, HELOC is technically still categorised as a second mortgage anyway.

Many also appreciate the flexibility. Unlike with a home equity loan, you only pay interest when you are spending money with the HELOC, whereas with a home equity loan you’d be paying interest every month.

What would suit you best? 

 

Those are the advantages. The disadvantage, and it’s a weighty one, is that with HELOC you are putting up your home as collateral. This is where you need to be careful, because if for whatever reason you are unable to make your payments or meet the terms, you risk foreclosure, thus losing your home. So if you don’t know how to control your spending with a credit card, a HELOC could be a risky option for you.

If you do trust yourself with buying on credit, a safe bet would nonetheless be to only use HELOC for major  items, such as home improvements, medical bills, college expenses or just to have money available in case of an emergency. Rather than using them for day-to-day expenses, which a credit card might be more suitable for.

About the author: Queenie Bates is an avid reader, researcher and writer, currently based in Cape Town, South Africa. She wanted to share the information she learned, because after searching for houses for sale Gauteng, she is exploring all her loan options.

* Image attribution: 401(K) 2013; CC BY-SA 2.0