Choosing the right loan should be as easy as buying a shirt at your local mall (or online if that’s more your speed). Seriously, it can be that easy—just familiarize yourself with the products and find the one that fits you best.
You likely already know that loans aren’t one-size-fits-all—just like that new shirt. They come in various styles and lengths, and meet the needs of many different situations. Learning the differences between products will help you find the right fit. Let’s break it down into the basic decisions:
Which Loan Type is a Better Fit? Personal or Home Equity?
The main difference between the two loan types is that one is secured by your home (home equity loan or line of credit) and the other is most often unsecured (personal loan or line of credit), meaning you don’t have anything to put up as collateral when you take out that loan. Choosing a home equity loan puts your house on the line if you become unable to pay—a great reason to consider credit life and disability insurance to protect against the unexpected!
Because your house is involved, home equity loans and lines may offer some tax write-off benefits, but thanks to changes in tax law, those benefits may not be as enticing as they used to be.
“Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.” - irs.gov.
So, if your draw to a home equity loan or line of credit are the tax benefits, make sure you’ll meet all the requirements to actually receive them. Consulting with a tax professional would be wise.
The next things to consider when looking at your options are the term and rate differences between the loan types.
How Do Terms and Rates Differ Between Home Equity and Personal Lending?
The higher rates of a personal loan or line of credit may make a home loan or line of credit seem like the obvious choice, but the longer terms of a home loan mean you’ll be paying longer. Let’s look at an example. Say you need a $15,000 loan. What would that look like as a home equity loan vs. a personal loan using the longest term of each loan type?
6-Year $15,000 Personal Loan
Interest rate: 10.99%
Monthly payment: $285.43
Total principal and interest: $20,551.27
20-Year $15,000 Home Equity Loan
Interest rate: 5.45%
Monthly payment: $102.76
Total principal and interest: $24,662.39
You can see that the lower interest rate and longer term of the home equity loan make the monthly payment significantly lower. However, those same factors increase the total cost of the loan. A shorter loan term is usually going to be the better financial choice in the long run, but you need to take the monthly payments and what’s affordable for you into account too. You won’t see any savings if you can’t afford to make your monthly payments.
Still not sure which option is best for your situation? What you’re planning to do with the money is a good indicator of which way to go. Are you paying off an existing debt? In a perfect world, you’ll pay off short-term debt with a short-term loan (e.g. personal loan) and a long-term debt with a long-term loan (e.g. home equity). It does depend on your circumstances and your complete debt picture.
There are some gray areas. Student loans and credit cards could be considered short or long-term debt depending on how you manage your finances. If you’re making just the minimum payments on either, you can expect to be paying it off for a long time. Depending on the interest rates for those debts (typically very high for credit cards) and the amount you owe, paying them off with a single loan over 15-20 years may still save you a significant amount of money.
Let’s say you owe that same $15,000 we looked at above on a credit card with a rate of 18.9%. Even paying $450/month, it would take you 284 months to pay off the debt—that’s 23.667 years. On top of that, you’ll end up paying $31,240.78 in total, more than double what you originally owed. And that’s assuming you never miss a payment and your interest rate doesn’t go up. In this situation, either the personal loan or the home equity would be a good choice. If you have other debts and are struggling to make ends meet, the home equity loan would drastically reduce your monthly payment and give you some financial breathing room. If the personal loan payment is doable, that option will save you the most money overall.
Borrowing for something like a big home improvement project would make sense to approach as a home equity loan or line of credit. Paying off bills from an unexpected medical emergency is more likely a candidate for a personal loan.
With any new debt, even if you’re refinancing an existing loan, you want to figure out what you can afford monthly and pay off the debt in the shortest timeframe that works for your budget. The longer the term, the more interest you’ll pay over the life of the loan.
There’s one more option to consider within the home equity and personal loan types.
Do You Need a Loan or Line of Credit?
While we’ve focused on home equity and personal loans for most of this discussion, there’s another way to borrow—lines of credit. GOLD offers both a home equity line of credit and personal line of credit. The biggest difference between a loan and line of credit is how you access and pay back the funds.
Loans give you the funds in a single lump sum payment. You’ll then pay the loan back in fixed monthly (or bi-weekly) payments and the interest rate will stay the same over the life of the loan.
Lines of credit are designed to give you more flexibility. They work similarly to a credit card. While you have a set line of credit limit, you can borrow just the amount you need, when you need it. Your payments and interest are variable, but you pay interest only on the money that’s withdrawn. A line of credit is a good option for an ongoing home improvement project with money due at different times. It's also great when there's a potential project on the horizon, or you're just planning for a rainy day, as it costs you nothing until you use it.
Want to Talk One-on-One?
Would you like some help choosing the loan right for you? Give us a call at 484-223-4216 to talk through your situation and budget with one of our lending experts. We’ll help you make the best choice for you.
About Cori Gosser
Cori is the Vice President of Lending at GOLD. She directs and coordinates all lending activities, oversees a staff of Loan Officers and Associates, and helps GOLD Members take charge of their financial futures with loan products that fit their needs. Cori genuinely enjoys seeing our Members save money and watching their credit scores increase and lives improve due to guidance from her department.
Better Borrowing - October 30, 2018
Learn the history of mortgage rates as well as the current details on which type of mortgage is best for you today and in the future! Turn to GOLD for all of your mortgage needs.