You work hard. You need a break. You need a vacation. But this time you need more than just a weekend at the lake. It's time for the big one: the dream vacation.
Whether your idea of a dream vacation is a two-week safari in Africa or an all-inclusive resort in Bali, the price of relaxation can be pretty hefty, especially for a family. While many would advise saving up for a lavish getaway, there are other ways to pay for it. A home equity loan may be an option if you're a homeowner.
- A home equity loan can be used for any purpose
- Home equity loan interest rates are much lower than credit cards
- Home equity loans offer fixed interest rates and terms so you can plan your expenses.
What is a Home Equity Loan?
A home equity loan is a loan secured by the equity in your home. Your equity is determined by how much your house is worth versus what you have paid into the mortgage. A home equity mortgage will let you borrow a portion of that equity, usually no more than 80%, to use for whatever you see fit and pay it back in fixed installments, with interest over the next few years.
Home equity loans are paid in lump sums so that the funds can be used for anything. Many people use them for home renovations, paying off high-interest debt, or paying for education. But paying for a much-needed vacation is also an option.
If you are going to go into debt of any kind for vacation, consider investing in travel insurance. With this protection, your loan won't be at the whims of a natural disaster, pandemic, or cancellation.
Determine Your Budget
The first step to deciding how to pay for your dream vacation is determining how much it will cost. With airline prices steadily rising, transportation will be your first expense. Flight prices are typically highest in the summer and around the holidays when children are out of school. Airline tickets are also affected by when you buy them and what day of the week you want to travel. If you're not traveling with children, consider the winter, early spring, and fall for your trip. Known as shoulder season, this can save some money on flights and hotels.
If you decide to drive instead of fly, take into account wear and tear on your vehicle and the price of gas. Another option is to rent a car to save wear and tear. Recent rental car shortages may impact pricing for rental cars as well. If you fly, think about how you'll travel around your destination. Is public transit accessible? Will you take guided tours that include transportation?
Lodging is the next most significant expense. If you have a family, you may need to consider booking several hotel rooms or looking into a short-term rental. Once food and entertainment are added in, it's easy to see a $10,000 price tag for a week of international vacation for a family.
Home Equity Loan vs. Credit Cards
Unless you are willing to spend the time and have the discipline to save for your trip beforehand, you may have to incur debt to pay for a dream vacation. While most people would use a credit card to book airline tickets, hotels, car rentals, and pay for food and incidentals, credit cards typically have higher interest rates. These interest rates are based on a prime rate plus a certain percentage and expressed as the annual percentage rate (APR). Currently, the average APR for credit cards is 19.49%, according to Investopedia's most recent survey.
Credit cards charge interest when you carry a balance from one month to another. While there are occasional promotions that offer zero percent interest for a period of time, not everyone is eligible for those cards. If there is a chance that you will carry a balance, finding a lower interest option is attractive.
A home equity loan is considered a secured loan because it is backed with collateral: your home. Home equity loans typically have much lower interest rates. However, many lenders have a minimum threshold for how much they will lend. While this is variable, $15,000 is a common minimum limit. Closing costs are also involved, so your ultimate bill will be between 2% and 5% higher to cover origination fees, appraisals, recording fees, etc.
Let's compare borrowing $15,000 for an African safari for a family of four. If this family borrows $15,000 through a home equity loan with a five-year repayment term, their interest rate would be 6.1%. With a $290 monthly payment, they would pay roughly $2,440 in interest fees over the loan term. That doesn't include origination fees, which could vary between $300 and $750.
Comparatively, if the same $15,000 were charged to a credit card and paid over the same term at an interest rate of 19.49%, the family would pay more than $8,000 in interest and have a monthly payment of $394. If they wanted to keep the monthly payment close to $290, it would take eight years and four months—and cost $15,234 in interest.
Risks of Home Equity Loans
Obviously, the home equity loan has a financial advantage over using a credit card, but there are risks involved. Although you'll have a better interest rate, you'll also be adding another payment to your monthly bills. And if you find that you can't pay your home equity loan, you risk losing your collateral—in this case, your house.
What's the Minimum Term for a Home Equity Loan?
This varies by institution, but most lenders have a minimum term of five years. Read your disclosure carefully; if there is no prepayment penalty, you may pay it off more quickly.
How Much Should I Budget for a Dream Vacation?
There are many variables to consider when vacation planning, starting with where you want to travel, how many people are going, and when you want to leave. Consider signing up for loyalty programs for airlines, hotels, and rental cars to travel more cost efficiently. They may offer discounts and promotions that can help you save money.
Does a Home Equity Loan Have a Variable Interest Rate?
It depends on the lender, but most home equity loans have fixed rates and fixed terms. Of course, there are exceptions to this. If you're looking for a variable rate or term, consider a home equity line of credit instead.
The Bottom Line
Ideally, vacation will be affordable enough that you won't have to worry about how to pay for it. But for the big, once-in-a-lifetime trips, you might consider financing. If you choose between a home equity loan and long-term credit card debt, the home equity loan is the more cost-efficient option.