HELOC: Home Equity Line Of Credit
Imagine you’re at a party, talking about what’s happened with home prices and how much more your home is now worth, and then suddenly people start talking about their HELOCs. You start to look for a way to change the subject, but it’s too late. Someone asks you if you’ve gotten a HELOC and now the truth is going to come out: you don’t really know what a HELOC is or how it works. Your only choice is to fake a nosebleed and gracefully flee the room. While that scenario might sound silly, if you’re a homeowner – or even contemplating becoming one – it’s important to know what a HELOC is and how it can fit into your personal financial picture. Intelligently and responsibly using credit can be the difference between living a comfortable life and feeling like all your money is going to paying interest with no hope of saving for the future.
HELOC stands for Home Equity Line of Credit. When you get a HELOC, you obtain a line of credit, which is essentially credit you can tap at any time – much like a credit card. Unlike a credit card, a HELOC is secured by your home’s equity, which is the value of your home minus whatever you owe on your mortgage.
“But I already have eight credit cards! Why do I need a HELOC?” Remember that a HELOC can be like a credit card, but they are different animals altogether. A HELOC brings some key benefits to the table that you simply do not have with a credit card.
Sure, your credit card might offer you a promotional rate for a couple of months, or even a year, but eventually you’ll be stuck paying astronomically high interest rates. This is because credit cards are unsecured debt – the credit card company is relying on your promise to pay back your debt, and not much else. They have to charge you sky high interest because of how many people run up credit card debts and don’t pay them back. In contrast, a HELOC is secured by the equity in your home. Because your HELOC lender will have a claim on your home, called a lien, they have additional assurance that whatever you borrower will be repaid – one way or another. As a result of this assurance, they can afford to charge you less to borrow money. This advantage is most obvious with credit cards, but often extends to personal loans (also unsecured) and even loans for things like motorcycles and recreational vehicles.
With the exception of credit cards, most loans are structured so that you pay them back over a fixed period of time. With a HELOC, you have a significantly longer period of time to pay back what you owe. This translates into a lower payment which gives you increased financial flexibility.
If you have two car payments, eight credit cards, and two or three home-related improvements you’re paying off, you’re juggling a lot of different numbers. Different interest rates, loan terms, and even loan balances can make it hard to figure what you should be paying off first. If you get a HELOC, you can use it to pay off all of those debts, leaving you with a financial picture that’s easier to understand. Instead of trying to guess what you should pay down first, you can simply focus on paying down your HELOC without any guesswork.
While big box hardware stores and various contractors may offer you financing, you could be setting yourself up for some surprises if you don’t pay off large bills in a matter of months. In contrast, with a HELOC you have a predictable source of funds with no “gotcha” type gimmicks, and enough time to pay off the amount you borrowed without needless stress. What’s more, you might even be able to deduct the interest you pay if you’re borrowing to make a home improvement – but be sure to talk to a tax advisor first.
It can sometimes feel intimidating to apply for credit. With a HELOC, you’re one and done, as opposed to the stress-filled process of applying for credit every time your financial needs change. By getting a HELOC, you go through the process just once – and it’s a far easier process than getting your first mortgage. After that, whenever you need more funds, they’re never more than a few mouse clicks away.
A HELOC isn’t simply someone throwing money at you from a helicopter. For starters, there is no helicopter involved, but beyond that, there are a few things you should keep in mind:
You will have to go through an application process, and it will result in an inquiry on your credit report. The good news is that if you are shopping for a HELOC, having multiple inquiries within a short amount of time won’t add up to a large impact. Your lender is going to look at your credit and the value of your home, and this is going to determine what size your HELOC is and how much your interest rate is going to be. Anything else is just an estimate. Pay attention to the details around your HELOC: Every HELOC has the potential to be different. Therefore, you’re going to want to read all your paperwork to understand what conditions may exist around withdrawals and the draw period.
It might be tempting to just Refinance your first mortgage as a method to extract equity from your home, but this could be a costly mistake – even if the mortgage rate you’re being quoted is less than what you could get on a HELOC.
|Interest for One Month
|Mortage + HELOC
In the simplified example above, you’d be paying $600 in interest on your first mortgage, and $200 in interest on your HELOC, for a total of $800 for a month’s worth of interest. If you divide that by the total amount owed, you’re looking at the equivalent of an all-in interest rate of 3.56%.
Meanwhile, the cash-out refinance in the scenario above would have you paying $1,350 in interest for the month – a whopping $550 more in interest.But there’s another way to look at this which makes you realize just how big a mistake refinancing your first mortgage could be in this scenario. There’s math involved, but I’ll handle the number crunching for you. If you take the interest cost of the refinance and subtract the interest cost of your original mortgage, you get $750. Take that $750 and multiply it by twelve to get an effective annual interest expense of $9,000. Dividing that $9,000 by the amount of equity you extracted results in an effective borrowing cost of 30%. Essentially, if you went the refinance route, you’d be paying credit card type interest rates to extract equity.
Because when you refinance, that new interest rate applies to the entire amount of money you owe. While your HELOC rate might be more than the rate on your existing mortgage or even a new refinance, your existing mortgage with your really low rate gets to stay in place.
**But it isn’t just about interest.
Remember that getting a new first mortgage can be a lengthy application process, with a lot of extra cost that you simply don’t have when getting a HELOC.
In addition, getting a new first mortgage often means that you’re extending the length of time that it’ll take to pay off your home.
The guidelines for getting a mortgage when you’re taking cash out can be stringent, and you may find that you can’t access nearly as much equity as you can via a HELOC.
We’ve spent a lot of time talking about the ins and outs of a HELOC, but it’s also important to identify some of the uses of a HELOC. While you can certainly go all Nick Cage and try to buy a T. Rex skull, there are some really practical uses for your new HELOC:
Everyone’s financial picture is going to be a bit different, but don’t just assume that student loans are the best way to finance higher education. Take the time to consider your options, understanding the interest costs, time it takes to pay back your debt, and what the monthly payment looks like.
Unless you’re planning to hop a plane to Vegas and use a coupon to get married at a chapel on the cheap, weddings can be an expensive proposition.
Whether you want to descend on an amusement park with your extended family, spend a summer touring Europe, or even travel around the world, a HELOC could save you a significant amount of money over paying for it all with credit cards.
Speaking from personal experience, it costs money to make money. Setting up an LLC, getting your business licenses, buying equipment, and even potentially needing to rent space – it all adds up. With a HELOC, you could have that money on hand so that you can quickly get up and running.
What’s the difference between someone like us and people that are extremely wealthy? Well, besides the fancy cars, mansions, and yachts, they also have less of their wealth tied up in their homes. If you haven’t been investing towards your retirement, a HELOC could provide enough capital to get you started. While investments, and even home values, can go up and down, having a diversified nest egg is a smart idea.
This one we’ve obviously mentioned before, but it’s worth mentioning again. Complicated finances are hard to manage, and it makes it easier to dig yourself deeper into debt.
Cars have gotten really, really, really expensive over the past few years thanks to all the new bells and whistles. While many car companies will find a way to finance your purchase without any money down, you might want to think twice. Without a down payment, you will instantly owe far more than the car is worth before the ink is dry on the paperwork. By putting a down payment, you can be in a better equity position from day one, which is useful if you ever need to trade the car in or if your car is totaled in an accident.
Whether it’s a want or a need, there are times in your life when you’re going to make a whopper of a purchase. While you could drain all the cash you have on hand, or max out your credit cards, a HELOC is a great way to lessen the immediate financial impact.
How many months of salary do you have saved up? If you’re like most Americans, that number is lower than the number of months you could be unemployed in the event of an economic downturn. With the cost of living these days, it’s increasingly harder to build enough savings to provide for peace of mind. A HELOC can take money that’s tied up in your house and give you liquidity for when you need it most. Remember, once you’re unemployed, your ability to obtain credit will likely be significantly curtailed.
Medical debt is a leading cause of bankruptcy, and can significantly impact your ability to obtain credit with reasonable terms. Having a HELOC in place means that you can not only help avoid taking on medical debt, but also deal with the occasional emergency without it blowing a hole in your budget.
Now that you’ve decided that a HELOC is the easy way to address your current financial needs, what’s next?
That’s where we come in.
You can Get pre-qualified for a HELOC in a matter of minutes with no impact to your credit score.
What’s more we can even help you figure out how much you could borrow, and how much you could save by consolidating your debts.
Once you’ve done your research, Hitch can make it quick and easy to get a HELOC with minimal out of pocket expense. You’ll even have a dedicated loan officer available to help answer any questions you might have.
With a HELOC from Hitch, you’ll enjoy the choice of 10 years of variable interest-only payments or a fixed rate that allows you to start paying down your HELOC immediately, the potential to borrow up to a total of 95% of your home’s value, the ability to redraw the money you’ve used to pay down your HELOC, and much more.
Borrow from yourself, not the bank!
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