Home Equity Line of Credit
Best if: You own a home and want a pot of cash to dip into.
The benefits: This type of loan (a HELOC, for short) usually gives you access to a large sum of money, but you don’t have to take the whole lot all at once. “A HELOC is handy if you want to have backup funds available in case of an emergency―for example, if you’re a freelancer with a variable income,” says Manisha Thakor, a coauthor of Get Financially Naked ($13, amazon.com). The line is backed by your home and is open for 20 to 30 years, but typically you can borrow only during the first 10 years (the “draw period,” in banking lingo). Applications take up to 45 days to process, but once the line is open, you can use checks or a debit card to spend the money on anything you please and the bank typically bills you only for the interest. The rate, while variable, can be lower than other options. And the cherry on top? Uncle Sam gives you a tax deduction for interest paid on balances of up to $100,000.
Worth knowing: The good times don’t last forever. Once the draw period is over, you’re on the hook for both the interest and the principal―and that can nearly double your monthly payment. Additionally, interest rates could rise, so “before accessing your line of credit, calculate whether you can afford a higher monthly payment,” says Tracie Southerland, a financial adviser in Palo Alto, California. (Use the calculator at mortgagesum.com.) And take note: Many financial experts suggest that your HELOC plus your mortgage not add up to more than 60 to 80 percent of your home’s value. So if you live an area where home prices are continuing to fall, you could see your equity line reduced or even cut off.
Best if: You own a home and need to make a major purchase right now.
The benefits: Home-equity loans are similar to HELOCs but differ in two important aspects. First, you borrow a lump sum of money at one time. And second, you lock in a fixed interest rate for the entire length of the loan, usually 10 to 15 years. If you want to renovate your kitchen or need to pay for your kid’s braces, you’ll get all the cash at once and you’ll know exactly how much you owe for the entire duration of repayment. Interest on borrowed funds is tax-deductible in many cases, but it’s more favorable taxwise to use the money to make home improvements.
Worth knowing: If you pay off the balance early, be prepared to get hit with a potentially expensive prepayment penalty (either a flat fee or a percentage of the full loan amount). And gone are the days when banks would gladly fork over up to 80 percent of your home’s value. “To keep from overextending themselves, they might now offer only a loan of less than 50 percent of your home’s value or equity,” says Thakor.
Best if: You don't own a home but need money fast.
The benefits: You can use this loan for just about anything, from medical bills to your daughter’s sweet-16 party. The amount you can borrow depends on the institution, and you can receive the funds the same day. There’s a set time period for repayment, and if you negotiate a fixed interest rate with your lender, you will reduce your risk of accumulating ever compounding interest debt.
Worth knowing: Apply at a credit union for the best deal. These lenders tend to offer lower rates (around 2 percent less) than banks do. True, you have to qualify to join a credit union, but membership rules have loosened (you may be eligible simply based on where you live or work, for example). To find one near you, go to cuna.org.
Peer-to-Peer Lending Website
Best if: You want to start or expand a business.
The benefits: Sites such as Lendingclub.com and Prosper.com are alternatives to bank loans, connecting borrowers with people willing to advance a preset sum of money. On the table: three-year, fixed-rate loans of up to $25,000 that you can usually receive within a few days after securing funding. These lenders are often more willing than a bank to dole out the cash: “Investors want more than a return on their money,” says Curtis Arnold, a coauthor of The Complete Idiot’s Guide to Person-to-Person Lending ($20, amazon.com). “They want to help someone.” You’ll also pay less: Interest rates can be several percentage points lower than rates at a bank.
Worth knowing: It helps to have a solid business idea and a healthy credit history. Lendingclub.com requires a minimum credit score of 660, and Prosper.com expects 640. Be ready to pay a fee of 0.5 to 3.75 percent of the total loan. The amount you borrow also plays a role in the interest rate; keep it at or below $10,000 for the best deals. Larger sums are possible but less common, so those loans typically carry higher rates.
Best if: You've built up substantial retirement savings.
The benefits: You’re borrowing from yourself, so as you repay the loan, the interest goes back into your account, not to a bank. You can borrow only 50 percent of your account’s balance or $50,000 (whichever is less), but the interest rate is low. (The typical current fixed rate is 4.25 percent.) And these loans are convenient to get. They often have online applications, there’s no credit check, and you can usually receive the cash within a few days.
Worth knowing: On average, only 59 percent of 401(k) plans have a loan option. (Check with your plan provider to find out if yours does.) Although you usually have five years to repay the loan, if you lose your job with funds still outstanding, you’ll have to pay the full amount back within 90 days or owe income tax on the remaining balance. In such cases, there’s also a 10 percent early-withdrawal penalty for borrowers under the age of 59½. Additionally, you give up potential profits if that money was invested in the market. From March to October, for example, U.S. stocks zoomed up 50 percent. So, borrower, beware.
It’s Not Quite a Loan, But...
If you want fast cash and need only a few months to pay it back, apply for a 0 percent APR credit card. (Search for offers at cardtrak.com and indexcreditcards.com.) You basically get an interest-free loan for six months or more―great for buffering those holiday expenses. Just be sure to pay off all your debt before the promotional period ends and the regular interest rate kicks in. Read the card agreement’s fine print for the exact end date, including the time of day. If you submit an online payment even a minute late, you could get hit with a late fee and the new interest rate.