Whether it’s home improvement projects, medical bills, debt consolidation, or just the unexpected twists and turns of life—sometimes we need extra cash flow. But when it comes to choosing a loan or credit option, the amount of choices can be overwhelming.
Of course the best method for covering big expenses is to save up an emergency fund in advance, but when that’s not possible, it may be time to consider your other options.
One of the biggest factors in choosing a credit or loan option is the type of expense you need to cover. Sometimes you may need to cover a single, large cost with an exact total that you know in advance. But just as often, you may be looking for a way to cover costs that you can’t predict or are spread across several months or even years.
Finding the balance between predictability and flexibility is a good way to narrow down the options to choose the right financial solution for your situation. Let’s look some of the most popular choices starting with the most flexible, multi-purpose ones and finishing up with the less flexible but more predictable options.
When to Use a Credit Card
While a credit card is one of the most flexible credit options available, you’ll often pay for that flexibility in the form of higher interest rates and shorter repayment periods. A good rule of thumb is that if you’re not absolutely sure that you will be able to pay off a credit card purchase in the same month you make it, it’s probably a bad financial decision to make. Still, there are smart ways to use a credit card, such as:
- Everyday purchases that you know you can afford
- Smaller emergency expenses that you expect to be able to pay off before the due date
- Building credit history with a consistent repayment schedule
Because of high credit card interest rates, unpaid credit card debt can quickly balloon out of control and stick you in a cycle of spending and repayment that is unhealthy for your long-term financial success. But as long as you are smart about the credit card purchases you make, a credit card can add flexibility and value to your financial life.
When to Use a HELOC (Home Equity Line of Credit)
Sometimes you might not be able to predict when larger costs are coming around the bend. If your emergency fund isn’t up to the task, and your credit card isn’t the right fit for the reasons outlined above, a HELOC can be a powerful second line of defense. Some of the best types of expenses to use a HELOC for include:
- Unexpected or urgent home repairs too large for a credit card
- General unexpected expenses or emergencies too large to pay off within a month
- Weddings, vacations, and other discretionary expenses that you don’t expect to pay off within the same month they are charged
What is a HELOC?
A HELOC is a revolving credit line allowing homeowners to borrow money against the equity of their home. Because it is a line of credit and not a fixed loan, borrowers can withdraw money from the HELOC as needed rather than borrowing one lump sum. This allows for more flexibility than a traditional, lump-sum loan and is especially beneficial for borrowers who don’t know exactly how much money they’ll ultimately need.
How Can I Use It?
Borrowers withdraw funds (aka “draws” or “advances”) from the HELOC during a set amount of time that is known as the “draw period,” which generally lasts 10 years. During the draw period, some lenders allow “interest-only” payments. In such cases, payments on the principle are usually optional and only become a requirement when the draw period ends.
How Does a HELOC help with Emergencies?
One of the biggest benefits of HELOCs is that many have no minimum withdrawal amount. That means you can apply for a HELOC and have a larger line of credit at your disposal with no requirement to use it. Even if you don’t expect an emergency to pop up, having your HELOC ready in case of emergencies can give you more peace of mind at times when your emergency fund is running low. Always read the fine print before applying to make sure that the HELOC you’re interested in does not have minimum draw requirements.
When to Use a Personal Loan
Personal loans come in a variety of shapes and sizes. There are unsecured personal loans, personal loans secured by collateral, and even deposit-secured loans. The best option for you will depend on your circumstances, but let’s look at some of the basics.
Secured Personal Loans
Secured loans allow you to get a loan that has been “secured” by collateral you already own, such as a vehicle (car, boat, etc.) or other asset (some lenders accept stocks, investment accounts, certificates, or savings accounts as collateral). They can be a good alternative to payday loans (usually secured against your next paycheck) or other high-interest options. Secured loans generally have lower rates than payday loans because they are backed up by an asset you already own, but always be sure to read the fine print on any loan you apply for. If the item your loan is secured against could change in value (such as an investment account) the bank could call in the loan immediately when the value drops below a certain limit. Typical reasons for using a secured personal loan might be:
- Consolidating higher-interest debt
- Covering an unexpected expense with a better rate than a credit card or other high-interest loan
Deposit-Secured Personal Loans
Deposit secured loans typically use a specified savings account or low-risk investment like a certificate of deposit as collateral. These loans are almost exclusively used to help build up a credit score for people with poor or no credit history. By securing the loan against a deposit, and allowing you to pay it off over a few months or years, you get a chance to build proven credit history by making payments on time. Typically deposit secured loans are only for:
- Building or rebuilding your credit history
Unsecured Personal Loans
Unsecured personal loans usually carry a higher interest rate because there’s no collateral being borrowed against. Still, they can be a better alternative to payday loans or other options with much higher interest rates and shorter repayment periods. People usually use them to:
- Pay off high-interest debt
- Help avoid getting into an very high interest loan such as a payday loan
When to Use a Home Equity Loan
A home equity loan is similar to a HELOC because it is also secured by the equity in your home. But unlike a HELOC, a home equity loan is a one-time, lump sum withdrawal rather than a credit line. While it may be less flexible than a HELOC, it is also more predictable because it usually has a fixed rate and a fixed repayment schedule. That makes home equity loans best for expenses like:
- A pre-planned remodeling project
- Refinancing an existing loan
- Medical Bills for Non-Chronic Conditions
- Consolidating high-interest debt
Home equity loans often have better rates than unsecured personal loans or other options because they are secured against your home equity. That makes them a good option for consolidating existing high-interest debt or getting access to funds without paying a premium in interest. They can be used to cover emergency expenses, but usually only when the extent of the emergency costs are already known.
As with any product or service, certain credit and loan options have different strengths and weaknesses. This guide can help you consider your options, but it’s best to talk to a financial consultant to determine with financial product best suits your particular needs. It’s good to know that when life happens—whether you choose a home equity loan, a HELOC, a personal loan, or a credit card—you have options to cover costs and keep moving forward. The key is to do your research, get sound advice, and make a plan that fits you.
This article is for educational purposes only. Tulsa FCU makes no representations as to the accuracy, completeness, or specific suitability of any information presented. Information provided should not be relied on or interpreted as legal, tax or financial advice. Nor does the information directly relate to our products and/or services terms and conditions.