Borrowing Money for Major Purchases

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Borrowing Money for Major Purchases

If you need to borrow for a big purchase, you have some options at your disposal.

Home equity line of credit

A home equity line of credit (HELOC) is a line of credit that uses your home as collateral. It is a revolving line of credit with a variable interest rate, rather than a closed-end loan. HELOCs are often used for financing large purchases, in part because the interest paid may be tax-deductible.

Based on the value of your home, your lender will approve a certain credit line—the maximum borrowed amount that can be outstanding at any one time. Once you are approved for the HELOC, you can draw from it whenever you want, generally with checks.

Second mortgage

Unlike a HELOC, a second mortgage gives you a fixed sum of money to be paid back over a set time. (Again, interest may be tax-deductible.) Equal monthly payments are usually required to pay off the full loan. Borrowers who need only a set amount rather than a revolving line of credit may find a second mortgage more attractive than a HELOC.

Compare the costs of the HELOC and the second mortgage. With both, ask if there are costs in addition to those you recognize.

Using credit or installment loans

Many borrowers take advantage of credit cards or installment loans. These allow the borrower to repay the lender in repeating monthly payments, with either a fixed or floating interest rate. Each payment is a combination of principal and interest.

Interest rates on credit cards and installment loans tend to be high, however, especially on credit cards. Indeed, if one makes the minimum required payment each month, only a small portion will go toward principal. For this reason, this type of borrowing is the least desirable way to finance a major purchase.