If you’re a homeowner with a mortgage, you have access to something called a home equity line of credit (HELOC). A HELOC is a very useful tool and is talked about pretty frequently. Read out what is Home Equity Line of Credit and how does it work?
But how does a Home Equity Line of Credit work? Why is it so important? How is it different from a home equity loan? And what is it useful for?
In this article, we’re going to tell you how you can use a home equity line of credit for your needs.
What is HELOC?
A home equity line of credit is exactly what it sounds like: a revolving line of credit that is borrowed against the equity value that you have in your home. Your home equity is used as collateral in case you don’t pay the loan back. As a result, HELOCs have very low interest rates compared to many other types of loan.
Your HELOC functions similarly to a credit card or any other revolving credit line: when you borrow against your HELOC, you accrue a balance. You then owe a payment to your lender based on the size of the balance and the interest accrued.
A HELOC is NOT a home equity loan. Home equity loans are single, lump-sum payments that you have access to right away in cash, and are often used to pay for large projects that have large immediate expenses. Keep reading on how does a Home Equity Line of Credit work?
How Do They Work?
So, how does a Home Equity Line of Credit work? Your HELOC will come with terms that specify how you can use it. Getting one is similar to getting a mortgage: you apply for it, and your lender gives you a list of terms for you to agree on. There is a complete list of how to prepare your credit for a low-rate mortgage. Approval depends on your income, debt-to-equity ratio, total debt, credit history, and credit score: just like a mortgage.
The size of the HELOC you get will depend on how much your home is worth, and how much you still owe on the home. Your limit won’t necessarily be equal to the amount of equity you have, and your interest rate will depend mainly on assessed credit risk.
An example of how a HELOC will be structured is that the lender may offer you a $100,000 HELOC at 3.5% interest with your home as collateral. They may allow you to draw up to $100,000 from the credit line in a 10-year period, and require that you only pay the interest for that length of time. Afterwards, the HELOC is put in a frozen status and you are then required to pay the balance.
You only have to pay for what you use. If you get a $100,000 HELOC and you only draw $20,000 from it, you only have to pay the $20,000 principal and the interest accrued on that $20,000: NOT the $100,000 you have available. In this way, it’s like a credit card(Also Read: What to do if you have credit card debt problems). A home equity loan, on the other hand, provides you with a lump sum of cash that you have to pay off right away. You might the idea of how does a Home Equity Line of Credit work?
What Are The Disadvantages of a HELOC?
The main disadvantage of a HELOC is that if you default on the loan, you could lose your home. That’s a big risk for many people, and it puts people off from using a HELOC.
Another big disadvantage to HELOCs is that the interest rates are generally variable. So when interest rates are low, you’re not paying much, but when the Fed decides to increase interest rates for economic reasons, you might be left holding the bag.
If you’re going to use a HELOC, please read the terms VERY carefully, otherwise you could stand to lose your home! Keep reading how does a Home Equity Line of Credit work and how could you use HELOC?
How Could I Use a HELOC?
- Student loans. Using a HELOC is a very common way for homeowners to pay the expenses of a child that is going to school, as the interest rates are lower and the terms are usually better overall. Not to mention, homeowners can take their time paying off the HELOC rather than having to be burdened with the home equity loan payments.
- Home renovations. This is a pretty common way a HELOC is used, as the home renovation is intended to increase the value of the home itself. Home renovations are expensive and often difficult to finance. A HELOC makes perfect sense for this.
- Estate expenses. If you recently inherited an estate, you can use a HELOC to help make the estate easier to liquidate by doing things like paying utility bills or fixing up the house.