Home Equity Line of Credit (HELOC)
Owning a home gives you the ability to build equity over time, and that equity can be utilized to acquire low-cost funding in the form of a second mortgage, either as a one-time loan or as a revolving Home Equity Line of Credit (HELOC). In this article we will be discussing the latter option, and we’ll be going over the pros, cons, and whether or not an HELOC is right for your individual circumstances.
Utilizing the equity that you’ve built up in your home can be a great way to access cash for a variety of purposes, such as renovating your residence, making large purchases, or paying down debt. These loans are secured against the value of the equity in your home, and with that being the case, lenders may be willing to offer lower interest rates when compared to other personal loan types.
An HELOC is a loan against the equity in your home – the difference between your home’s value and your mortgage balance – that essentially takes the form of a revolving source of funds functioning in a similar manner to a credit card that can be accessed as needed by the homeowner.
Of course, there are also potential downsides when using your home as collateral for a loan; for example, if you fail to make payments, lenders can place a second lien on your home, giving them rights to it along with your original mortgage lien. And the risk gets higher the more you borrow against your home.
There are differences between HELOCs and traditional home equity loans. As stated above, they function as a revolving source of funds that you can choose to access as needed, similar to a credit card. Lending institutions typically offer several different ways to access the funds, such as writing a check, making an online transfer, or utilizing a credit card that is linked to your account. In contrast to normal home equity loans, HELOCs typically have little in the way of closing costs and normally feature variable interest rates, although fixed rates for a set number of years are sometimes imposed by some lenders.
One big advantage of an HELOC is that it offers a great deal of flexibility; for example, the available funds that you do not tap into do not accrue interest until such time as you utilize them. With that being the case, a HELOC can function as an effective source of emergency funding – for example, if you lose your job or need major home or automotive repairs – provided your bank doesn’t have a minimum withdrawal requirement.
But once again, the major con when it comes to HELOCs is that you are using your home as collateral for it; if you are unable to repay the funds you have utilized from your HELOC – for any reason – the lender could potentially foreclose on your home. Therefore, it is essential to only spend the funds on essential things or risk accruing significant debt and budget strain, up to and possibly including the loss of your home.
An HELOC normally works in two phases; the first is typically a 10-year draw period, during which the borrower is allowed to access the credit available to them as they choose. During the draw period, only small, interest-only payments are required to be made, although the option may be available to pay over and above that amount towards the principal.
At the end of the draw period, the borrower may at times be allowed to ask to extend the HELOC; if this is not the case, then the loan enters the second phase, which is repayment. During this phase – which typically lasts for a period of 20 years – the borrower can no longer access their HELOC funds and is required to make regular principal-plus-interest payments (the interest rate is set in the contract signed at the time that the loan is taken out) until the loan is paid off in full.
HELOCs are different in many ways from a standard line of credit and can offer several advantages over them; however, one potential issue could arise from the fact that if a borrower makes interest-only payments during the HELOC draw period, the payments they will be forced to make in the repayment period can be almost twice as much.
Case in point: if a borrower takes out an HELOC for $80,000 that has an annual percentage rate (APR) of 7 percent, the amount they would be paying during the 10-year draw period – during which interest-only payments are required – would be approximately $470 a month. When the repayment period kicks in after that 10-year time span, the monthly payment amount could potentially increase to as much as $720 a month, which could result in serious budgetary strain if a borrower is not prepared.
With that in mind, if it is possible to acquire an HELOC that allows you to pay over and above the interest-only payments so that some of that money is going towards the principal – and you have the financial ability to do so – then that is a recommended avenue of action to take.
Once you have successfully acquired an HELOC, it can be utilized for a number of helpful things, such as renovations and remodeling projects on your home that would serve to increase its value and increase its available equity. Other uses would be paying off a high interest rate debt – such as a high-rate credit card balance – as an alternative form of debt consolidation, essentially using a secured, low-cost form of credit to replace a high-cost loan.
Also, if you’re able to write off the interest you’re paying, an HELOC may yield a tax benefit; if deductions are itemized and certain requirements are met, the Internal Revenue Service (IRS) allows borrowers to write off some of the interest on home equity credit.
Options and fees when it comes to acquiring an HELOC can vary wildly from one lender to another, so it is highly recommended that you shop around in order to ensure that you procure the best possible terms for yourself. HELOCs are offered by a variety of lending institutions, such as traditional banks, savings and loans, credit unions, and mortgage companies.
If the process of shopping around for an HELOC is a bit daunting for you, you can also hire the services of a mortgage broker such as myself to do the legwork for you. Also, bear in mind that some lenders are willing to negotiate on some of the fees associated with HELOCs.
Sooner or later, everyone encounters financial hardship when going through life, and the ability to tap into some extra funding when necessary could go a long way to easing any unexpected burdens you may be experiencing. An HELOC may be just the thing you’re looking for, and given the fact that it’s secured against the equity that you’ve built up in your home, you could potentially get it for a lower interest rate than most other loan types. As with any type of loan, there are risks associated with HELOCs, so it’s best to consult with a financial professional and find out if it’s right for you.