You may be considering a home equity line of credit (HELOC) to gain access to the value you’ve collected in your home, also known as equity. HELOCs work much like credit cards. Based on your home’s equity, you’re given a set credit line where you can then withdraw money from as needed.
HELOC funds can be used to pay college expenses, remodel your home, or build a vacation fund. They also can be useful for people who need another way to pay off high-interest debts.
But is a HELOC a good idea? Keep reading to learn more!
WHY HELOCS ARE A GOOD IDEA
Many reasons make a HELOC a good idea and attractive option for homeowners looking to tap into their home’s equity. They can be used for a variety of reasons and offer a unique level of flexibility. And there are many other reasons to consider a HELOC.
HELOCs come with flexible term lengths, which allow you to borrow only the amount you need. You may have access to a $30,000 credit line, but if you only need half of it, there isn’t a need to pull out the rest that costs you more in interest than needed.
HELOCS offer the most flexibility in how funds are used. Use the money however you want but have a set plan for how you will use and repay the funds too. Keep in mind that a HELOC is tax-deductible if you use the money to renovate your home. This is a great way to check off the home renovation process you’ve been putting off without breaking the bank!
HELOCs are a good idea because they start with a lower interest rate than most other sources of funding. You’ll want to remember the rate is adjustable – meaning it can increase or decrease over time according to designated benchmarks.
This does mean that your monthly payment may increase or decrease as well. If you currently have a good interest rate, a HELOC will allow you to maintain that rate while still obtaining cash to use however you want.
HELOCs usually have lower interest rates than mortgage payments. When you’re approved, you could choose to pay off your mortgage right away and then make payments to your HELOC instead. Be sure to pay attention to the terms on your HELOC compared with your mortgage.
A HELOC may also be a good idea because of credit limits. HELOCs typically offer higher credit limits than other loans.
At Wasatch Peaks, our HELOC amounts will differ given these three criteria: the value of your home, the percentage of value your current lender allows you to borrow against, and the amount still to be owed on your existing mortgage. This determines your specific credit limit when approved.
For example, if you own a $300,000 home with a mortgage balance of $175,000 and your current lender allows you to borrow against 85% of your home’s value, multiply your home’s value by 85%, which equals $255,000. If you subtract the amount you still owe on your mortgage, the result is $80,000. This is your maximum HELOC credit limit.
WHEN TO RECONSIDER A HELOC
While there's a lot to like about HELOCs, there are potential pitfalls to look out for as well. Most can be avoided with a little planning, but you want to be aware of them going into the application process.
Be aware of the interest-only payments specific to HELOCs. During your draw period, which can last up to 10 years, you may be allowed to make interest-only payments on the amount you borrow. When this period expires, you will be responsible for paying both the principal and interest until the end of the loan term.
Be prepared for these expected increases especially if you’re sticking to a tight budget. Unlike standard signature loans, your home serves as collateral for a HELOC. This means if you’re ever unable to make payments to your loan, it could default. Avoid foreclosure by ensuring to make all payments on time and in full!
Choosing a HELOC or Home Equity Loan
A HELOC and a home equity loan are both ways to finance large expenses by borrowing against the equity built in your home.
As we discussed, HELOCs can help cover ongoing costs. Home equity loans are suited more to one-time expenses. A HELOC and a home equity loan are also examples of a second mortgage, a loan that uses your house as collateral.