Home equity lines of credit (HELOCs) are often touted as the fastest way to free up cash in your home. But before you apply, it’s important to know what they are, how they work, and what the benefits and drawbacks are. Here’s all you need to know about HELOCs to decide if it’s right for you.
What Is A Home Equity Line Of Credit (HELOC)?
Using a home equity line of credit, homeowners can borrow money against the equity in their home and receive the funds as a credit line. You can use HELOC funds for a number of purposes, including home improvements, education, and consolidating high-interest credit card debt.
A home equity line of credit (HELOC) is the ability to take cash out of the equity that you’ve built in your home, while still keeping the home as collateral. Whenever you repay any of your loan, your available credit is replenished like a credit card.
With a home equity line of credit, you can borrow again and again and set the terms to be just what you need. You have the credit line (a loan from the bank up to the value of your home), plus the maximum number of extensions that you choose for the term of your line of credit (typically 10 years). After the draw period ends, the repayment period (typically 20 years) begins.
Benefits Of A HELOC
If a HELOC allows you to consolidate your debts at a lower interest rate, it can be a useful option. Only what you borrow currently has to be repaid with interest.
A HELOC is also flexible, and can be used for whatever you need it for, including college tuition and other education-related expenses. That being said, make sure you understand the risks before getting a HELOC. For example, it may not make sense to take out a HELOC in order to live a luxury lifestyle and buy an expensive car. Whatever you decide to do, it’s wise to consult with an attorney or tax professional.
If you need to borrow a large sum of cash for a costly home improvement project, a second mortgage may be your best option.
You can also borrow as much as you need with HELOCs, which is useful in situations where the cost of an investment or project is not yet known. The result can be an understatement of your costs, which then allows you to charge less interest to pay it back.
Speaking of home improvement, a HELOC’s interest is deductible if you use it to pay for home improvement.
Whatever you decide to do, make sure you understand the ins and outs of a home equity line of credit before making any moves.
Drawbacks Of A HELOC
It’s important to prepare for upfront costs. You may need to pay an application fee, home appraisal, title search and attorney fees before you receive your HELOC. Additional up-front costs may not be worth it if you are only borrowing a small sum of money. They may, however, be ideal if you are struggling to pay off a mortgage. When looking to get a HELOC, it’s crucial to understand your finances, and it would be wise to consult with a lawyer or tax professional.
When you take on a debt tied to your home, there is always risk involved. If you’re not able to make payments on your HELOC, the government may take your home because the loan acts as a sort of guarantee for them.
These rates may increase in the future, so make sure you watch out for fluctuations in the market. As a mortgage reaches the point where you must start making payments beyond just the interest on the principle, you could feel the hit to your finances. Be sure you can still afford any rate fluctuations.
It might not always be the most practical option. If you do use a HELOC for everyday expenses, be sure to be careful about it. Although it starts to feel like any other credit card, you are trading up some of your most valuable asset–your home–for the money you borrow from your home equity line of credit. It’s usually not a good idea to use it for anything but financial advances like increasing the value of your home, or going to college.
Is A Home Equity Line Of Credit Right For Me?
A home equity loan – or any loan for that matter – would probably be a poor choice if you want to cash out your home equity to gamble at the local casino. Despite this, home equity loans can be made use of in many practical ways, and even be used to save money over time.
Remember that if you consolidate your debt from a credit card or personal loan into a home equity loan, you’re exchanging unsecured debt for secured debt. You’ll likely reduce your interest rates in the process, but if you don’t pay it back, your home will be threatened. If you don’t pay your debt, no matter what form it takes, you could still suffer negative consequences. Leaving your debt in an unsecured vehicle like a credit card eliminates that risk.
To illustrate, on one hand, in the case of an HELOC and its ability to often cost less in interest than one’s credit card or car payments, it may make sense to choose it over consolidating debt and getting a card with a higher rate of interest.
This same logic holds when dealing with personal finances. On the other hand, using a home equity loan to buy a frivolous purchase, like a luxury vacation to Greece, should not be on the table for those looking to maintain their solvency.
That said, there are a number of reasons why you may consider a home equity line of credit.
- Emergency expenses: In the event that you do not have sufficient cash reserves for a sudden expense, such as car repairs or a sudden illness, borrowing against your house’s equity is a low-interest option.
- Debt consolidation: If you are overwhelmed with credit card debt or have a personal loan with a high interest rate, you may be able to refinance them and lower your payments by using a home equity loan. Home equity loans will typically have a much lower interest rate than a credit card or personal loan, so you can reduce the payments, interest and repay your debts at a fixed interest rate over a predetermined timeframe.
- Major home improvements: Many homeowners use home equity loans to fund the cost of projects like kitchen remodeling, room additions, or new flooring. One of the best parts of this type of loan is the low fixed interest rate that comes with it.
- College expenses: On top of affording for part of a college tuition, home equity loans can also help loved ones avoid expensive student loans and a crippling load of debt in the long term.
How Do I Apply For A Home Equity Line Of Credit?
One step in applying for a home equity loan is having a decent chunk of equity in your home, so you can qualify for it. Typically, lenders won’t let you borrow over 85% of the total value of your house minus what you owe, or your mortgage.
So if you already owe $600,000 on your house, you could qualify for another $37,500 by taking out a home equity loan. If your home is currently worth $750,000, you could owe a total of $637,500 on your mortgage plus a home equity loan.
Generally speaking, in most cases, you’ll need your property appraised to ascertain how much it’s worth today. Your mortgage provider can often handle this for you, although it will typically involve an appraisal fee.
If you want to qualify for a home equity loan, your credit score is yet another factor to consider. Although each lender has its own requirements, you’ll have the best chance at approval if your FICO score is at least “good” – meaning a score over 670. FICO scores of 740 and higher will increase your chances of getting the best rates and terms on a HELOC.
The Difference Between HELOCs And Home Equity Loans
A home equity loan works similarly to a HELOC in that it is a type of loan offered by a lender who is interested in the equity you’ve built up in your home. Like a HELOC, your home is the collateral on the home equity loan, so if you cannot afford the payments, you may lose your home. Home equity loans provide pre-determined monthly payments with a set interest rate. Unlike a HELOC, you cannot add more funds to your home equity loan, so it’s ideal for people who know the exact amount of money they need for the house.
Final Thoughts On Home Equity Lines Of Credit
A HELOC could be the right choice for you if you need revolving funds to keep up with your home improvement needs. In case you know how much money you need for a project and are looking for fixed monthly payments, you may be better off with a home equity loan.
