Most financial advisers suggest putting aside money into an emergency fund that covers major unexpected expenses like health issues, loss of employment, or another sudden setback. They may advise saving three to six months of expenses in a separate “emergency fund” account that you only withdraw from in one of these extreme instances. We agree with this advice, but not everyone is able to accumulate six months of expenses quickly. Then what happens when an unexpected major setback occurs while they are saving up?
Most people take out their credit cards and start racking up debt. Large credit card debts with high interest rates can take years to pay off. People may know the perils of credit card debt , but they feel stuck in a position where there is no other choice.
There is often a better choice.
HELOCs: The Better Choice
Home Equity Lines of Credits (HELOCs) allow you to use equity in your home to pay for unexpected bills or make much-needed repairs to your home. Your bank typically will offer much lower interest rates on such loans than your credit card interest would be. In addition, a good community bank will sit down with you and personalize the terms of the loan to fit your needs, something that is virtually impossible to do with your credit card.
Comparing the Rates
Let’s take a closer look between credit card interest and HELOC interest.
First, do not be confused by news that credit card interest rates are falling or that HELOC interest rates are rising. Such news may be true, at times, and important to consider in aspects of your financial life. The rising and falling of rates can be significant. But when you are comparing credit card interest to HELOC interest, regardless of the latest trends, credit cards rates are always simply higher.
The average credit card interest rate is between 13 and 19 percent. Historically, credit card interest has been well over ten percent–typically closer to 20 .
HELOC rates are historically well below 10 percent and have even been below 5 percent. Even if credit card rates hit recent lows and HELOC rates hit recent highs, HELOC rates will still be below credit card rates.
We are not advocating against credit cards broadly. It is generally a good idea to have a credit card–if you know the times to use it.
The Time for Credit Cards
Credit cards are for expenditures that you can pay off timely with little or no interest accumulated. Credit cards are for renting a car, going on a trip (some airlines, for instance, will only accept credit cards for baggage), or paying monthly, recurring bills. Credit cards can be a good way to build credit (and even earn points to free prizes or perks like travel points, as long as your gains are not wiped out by large annual fees). Yes, it is in fact a good idea to have a credit card, if you are using it optimally to avoid credit card interest.
Unfortunately, less than one in three people pay off their credit card bill each month. Certainly, at times this is simply because of overspending or problematic budgeting, but in other instances it is simply about taking on the wrong type of debt. In your financial life, you may not be able to avoid debt and interest altogether. But you can take on smart debt.
The Time for HELOCs: The Smart Debt
The smart debt for major unexpected expenditures or big projects that will take a longer time to pay off is often HELOCs. In addition, HELOCs are good for expected long-term expenditures like college tuition, etc. HELOCs are not for everything–such as renting a car, or paying monthly bills as listed above or other items that are more ideal for credit cards–but HELOCs do have their time and place. So if you need to consolidate your debts or pay unexpected bills, HELOCs are something to look into.
HELOCs are not better than credit cards and credit cards are not better than HELOCs. But each one is better in certain instances. And it is important–and financially beneficial–to use the appropriate credit line for the appropriate expenditure. Simply by doing that, you can save yourself a lot of money.
Don’t own a home? Don’t worry, HELOCs are not the only line of credit available. Check out other lines of credit here: https://www.oakbank.com/personal-banking/personal-lending/#personal-loans
And if you have a business, check out other lines of credit here: https://www.oakbank.com/business-banking/business-lending/