Should You Use a Home Equity Loan or Line of Credit for Vacation?November 13, 2018 - by Kimberly Goodwin, PhD
Although the staycation has become a popular phenomenon for those who don’t have the time or money to leave home, most people want to be able to afford a nice vacation. Whether it’s a family trip to Disney World, a trip to the beach with friends, or an international adventure, vacations give you the opportunity to get away and see the world from a new perspective.
Unfortunately, a 2017 survey reported that around 57 percent of Americans have less than $1,000 in a savings account. In addition, 21% of adults didn’t have a savings account at all. So, most people who want to take a vacation have to borrow the money.
One method for paying for vacation involves just charging everything with a credit card. Alternatively, borrowers may consider using a home equity loan or home equity line of credit to pay for their vacation.
Home Equity Loan for Vacation
A home equity loan allows homeowners to borrow against the equity in their homes. The amount of equity that borrowers can get is determined by the amount of equity they currently have. Equity is the difference between the current market value of the home and the current outstanding mortgage balance.
Compared to other forms of borrowing, a home equity loan is a relatively inexpensive source of cash. The interest rate on a home equity loan is typically only slightly higher than the interest rate on a new mortgage. Furthermore, home equity loans usually have terms that range from 10 to 15 years.
On the other hand, there are risks associated with using a home equity loan to finance your vacation. Since the loan is secured by the borrower’s home, the borrower could lose that home if they default on the loan. So, you’ll need to consider if your vacation plans are worth the potential risk of losing your home.
Home Equity Line of Credit for Vacation
A home equity line of credit (HELOC) is similar to a home equity loan. With a HELOC, the homeowner can choose to borrow up to the full amount of the credit line at any point in time. Homeowners continue to have access to the credit line as they make payments on the balance.
A HELOC can be useful as you are planning a vacation because the lender often gives you checks or a debit card to access your credit line. As with the home equity loan, however, it is important to consider the potential downside risks of using home equity to fund a vacation.
Alternatives to Consider
Another potential way to fund your vacation is with credit cards. Many credit card companies have special types of credit cards that allow users to gather rewards points that they can use on travel. Using one of these credit cards could be a good way to finance a trip today while earning rewards that you can use for future vacations. The interest rates on credit cards, however, are typically high.
Borrowers may also be able to get money for a vacation by using a personal loan. Personal loans are an unsecured type of loan, so the interest rates are also much higher than they are for a home equity loan or home equity line of credit. The interest rates are much lower than they would be for credit cards or other types of debt. Overall, borrowers need to consider how much money they need for their vacation as well as the effective cost of the loan.
How Could This Impact Your Credit Score?
All things being equal, taking out a home equity loan or home equity line of credit to pay for a vacation will cost less than using a credit card or personal loan. In addition, credit-scoring models seem to favor secured forms of debt like mortgages and home equity loans over unsecured credit.
So, if you are choosing between carrying a high balance on a credit card and using a home equity loan or line of credit to finance your vacation, home equity is the better choice for your credit score. Keep in mind, however, that you are still increasing your overall debt burden, which is bad for your credit score. Increasing your overall debt burden also increases your financial risk.
Saving money to help pay for your vacation is always the best option. A HELOC, however, will let you pay off the cost at a relatively low interest rate over many years. So, it’s the most affordable option if you decide to borrow. Just don’t neglect to consider the risks to your home when you use home equity debt.
Author: Kimberly Goodwin, PhD
Dr. Kimberly Goodwin is currently the Parham Bridges Chair of Real Estate and an Associate Professor of Finance at the University of Southern Mississippi. She holds a B.S. in Geophysics from the University of Delaware, a M.B.A. from the University of Southern Mississippi, a M.S. in Finance from the George Washington University, and a Ph.D. in Finance from the University of Alabama. Dr. Goodwin’s research focuses on real estate markets and has been published in some of the top real estate journals. She is also a Co-Editor for the Journal of Housing Research.