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The holidays are a magical time of the year -- for the most part. One potential downside to the holidays, however, is that they can easily become a source of debt and even damage your credit score. In fact, if you're not sure how you'll pay for the upcoming holidays, you may be thinking of taking out a personal loan or simply racking up a larger bill on your credit card.
But what if you're a homeowner? Should you borrow against your home to cover your holiday purchases, or is that a big mistake?
The problem with borrowing against your home
There are several ways you could borrow against your home. A mortgage refinance is one option, or you could take out a home equity loan or home equity line of credit (HELOC).
A home equity loan, lets you borrow a lump sum and pay it off in fixed installments over time. With a HELOC, you get access to a line of credit you can draw from as needed. You'd then repay that loan over time, only your payments can fluctuate, since HELOCs tend to come with variable interest rates.
Another option is to do a cash-out refinance on your mortgage. If you go this route, you'll refinance your existing loan and borrow more than what you owe on it. The excess funds can be used as you please, so if you need that money for the holidays, that's your call.
Borrowing against your home via a home equity loan or HELOC is fairly easy. Since your home is used as collateral for that loan, your credit score is less important. With a cash-out refinance, however, you will need good credit to qualify.
But there are a couple of reasons why none of these options are great when it comes to financing holiday purchases. First, they can all come with expensive closing costs. Imagine you take out a home equity loan or HELOC to pay for the holidays. You could easily be charged up to 5% in closing costs. You might pay a similar percentage if you do a cash-out refinance. And to be clear, that 5% would be on your entire loan amount, not just the amount you borrow in excess of your remaining mortgage balance.
The second reason why borrowing against your home to pay for the holidays is a bad idea boils down to the risk of falling behind on your payments. If you fail to make payments on a personal loan, it will hurt your credit score. That's not a good thing, but it's pretty much the worst repercussion. If you fall behind on your home equity loan, HELOC, or mortgage payments, you could actually risk losing your home.
A better bet for the holidays
Your best bet for the holidays is not to rack up any debt at all, and only buy the things you can afford. But if you insist on borrowing, it could actually pay to opt for a personal loan instead. You'll likely pay similar closing costs on a personal loan as the ones described above. But at least your home won't be used to secure that loan, so there's a little less risk involved.
Another thing you should know is that lenders often impose a minimum when it comes to home equity loans. The amount you need to borrow for the holidays may be well below your home equity lender's minimum threshold. The minimum amounts on personal loans are usually much lower.
Of course, a cash-out refinance might still be the right move. For example, perhaps you were thinking of refinancing your mortgage anyway to snag the competitive rates that are available today. Or maybe you have other expenses you need money for, like a specific home repair. But don't refinance your mortgage for the sole purpose of covering your holiday costs -- that's a cumbersome, time-consuming process you're likely to regret.
Another thing is that mortgage refinances take time to close on, so unless you move immediately and your lender is quick, you may not even have your extra money in time for the holidays. Personal loans, on the other hand, can often close within days of your application.
Be careful with holiday debt
No matter how you end up borrowing money for the holidays this year, don't make the mistake of going overboard. The less debt you accrue, the easier and less stressful it'll be to pay it off.