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Smart buying: credit cards vs. home equity loan vs. personal loan

You're about to make a large purchase for your home. You've done your product research, checked out Consumer Reports and user reviews. You've shopped around to see where you can get the best deal. You may think you are all set to buy, but there is one more thing you have to research: the most cost-effective way to pay for this purchase.

Credit cards vs. home equity loan vs. personal loan

Your first instinct when making most purchases is probably to reach for a credit card. That's understandable, credit cards are convenient, have already approved your access to a certain amount of money, and have flexible repayment terms. Still, there may be better options when it comes to large, non-routine purchases.

Personal loans and home equity loans may be cheaper, more manageable financing options than simply charging something to your credit card. So how do you decide? Is it better to take out a personal loan or use a credit card? Where do home equity loans fit into the picture?

Each form of financing has its advantages and drawbacks, and understanding those pros and cons can help you recognize which best fits your situation.

Credit cards: pros and cons

As mentioned above, credit cards are generally a convenient payment option. Not only are they already in your wallet, but using them saves you the time and expense of a loan application. They also give you a great deal of latitude in terms of how quickly you repay what you borrow.

On the other hand, credit card interest rates are more expensive than either personal loan or home equity rates. That doesn't matter if you pay your credit card off every month, but when it comes to major purchases that may cause you to carry a balance for a while, those higher rates may become an important factor.

Speaking of carrying a credit card balance, those flexible repayment terms are a double-edged sword. Yes, credit cards require only a low monthly payment that allows you to stretch your debt out when money is tight, but that can mean paying interest over a longer period of time. Also, not sticking to a regular repayment schedule can make you less disciplined about your budget, resulting in spending more than you should.

Overall, credit cards are best suited to routine expenses that you can readily repay. To put it differently, they are best viewed as a convenient alternative to cash rather than an efficient method of financing for anything you are going to have to pay off over several months.

Personal loans: pros and cons

A personal loan from a bank or finance company typically carries a lower interest rate than a credit card does. It also puts repayment on a regular schedule, which makes it easier to manage a budget and stay on track toward paying down the debt.

One drawback is that a personal loan is likely to require that you have a good, steady income and a favorable credit history. Choosing a secured loan, which uses some of your property as collateral, may make it easier to get approved for a personal loan, but it also effectively ties up that property while putting it at risk if you fall behind on your payments.

Also, using a personal loan as an alternative to charging something on a credit card opens up the temptation to use your credit limit to buy other things. A personal loan should be used as a cheaper alternative for financing a purchase, not as a means of financing additional spending.

Using a home equity loan: pros and cons

A home equity loan is likely to have an even lower interest rate than a personal loan, and shares the characteristic of giving you a fixed schedule of regular payments.

Of course, getting a home equity loan depends on you owning a property with sufficient equity to qualify. If you use that equity for a loan, it may reduce your flexibility to make other moves later on, such as refinancing the mortgage or selling the home if the price dips a little.

Finally, there's the risk. Even if a home equity loan is your cheapest financing option, it may put your most valuable possession at risk. Before you put your home on the line, make sure you can comfortably handle the repayment schedule.

Debt consolidation allows you to change your mind

Sometimes a purchase decision happens quickly and you may already have gone with the default option of using a credit card. Even so, it's not too late to find a more efficient form of financing.

Debt consolidation loans can be used to reduce interest expense by paying down credit card debt, and as the name suggests, they can also be used to narrow a variety of debts down to one monthly payment.

Can you use a home equity loan to pay off credit cards? Yes, and personal loans are also a debt consolidation option. In each case though, you should only take this step if you have carefully planned for how the repayment schedule fits into your budget.

The takeaway is this: Savvy consumers don't just research what they buy, but also how to pay for it.

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