What is a HELOC?
Commonly known as a HELOC, a home equity line of credit allows homeowners to unlock their property’s accumulated equity. Using real estate as collateral, a HELOC is a loan that is secured by your home’s equity.
But, what does this really mean, and how does it all work?
If you are a homeowner unfamiliar with the home equity line of credit, we’d love to introduce you to HELOCs. Here is an overview of all things HELOC — what it is, how to get one, what you can do with it, and more.
A home equity line of credit is a second mortgage that homeowners take out on their homes, allowing them to borrow funds against their equity.
By leveraging home equity, a HELOC provides homeowners access to cash that can be used to address a variety of needs — from home renovations, debt consolidation, medical bills, or even financing the vacation of a lifetime.
Since a HELOC uses your home’s equity as collateral, borrowing qualifications are boosted. This gives homeowners access to favorable loan terms on their HELOC that they might not be able to access elsewhere, like on their first mortgage or on alternative credit lines.
The amount you can borrow using your HELOC is directly related to the amount of equity you have built up in your home.
The most popular benefit of taking out a HELOC? Low interest rates.
HELOCs usually offer a lower interest rate than other credit lines and loan types. The most common interest offering on a HELOC is a variable rate based on a prime rate. If you have a strong credit history and a high credit score, you will qualify for lower interest rates compared to homeowner applicants with weaker credit.
In addition to competitively low interest rates, HELOCs offer qualifying homeowners a myriad of benefits, such as:
Disadvantages to Be Aware Of
To make an informed decision as to whether or not a HELOC is ideal for your current situation as a homeowner, it’s important to understand the potential drawbacks associated with HELOCs.
Like any loan type, a HELOC is technically a form of debt. If not leveraged wisely, overspending on your HELOC can actually increase your monthly payment responsibilities — ultimately putting you in a less-favorable financial position, if you cannot comfortably afford the increased bill.
Another thing to be aware of is that, as a variable interest rate loan, your monthly payment amount is subject to change based on the prime market rate. While it’s great news to see your monthly payments reduce due to drops in interest, increasing interest may not be as welcomed.
If you are worried about the variable interest rate causing unpredictable changes to your monthly finances, you can shop for a HELOC that allows you to convert the balance to a fixed rate, or take a fixed rate draw.
Talk to your lender about these flexible options when you are performing due diligence on HELOC offerings.
The ideal candidate for a HELOC is a homeowner that meets the following criteria:
If you meet these qualifications, the next question you should ask is, is now the right time to take out a HELOC?
To determine if now is a good time for you to take out a HELOC, you should think about how you plan on using the funds. For example, you may have a pressing need requiring financial attention — or perhaps you simply want to build up cash savings as an emergency fund.
Another consideration is how you will make the monthly payments on your account balance. A HELOC is broken up into two distinct phases: the draw period and the repayment period.
During the draw period, homeowners are able to access cash. The money you borrow during this time establishes your balance. During this phase, homeowners have the option of paying the minimum monthly amount or only the interest on their HELOC balance. Some HELOC providers, like Hitch, offer a ten-year interest-only period to help homeowners manage their finances.
Once this period comes to an end, the repayment period begins. Lasting anywhere from five to twenty — or longer — years, homeowners can no longer pull cash out of their HELOC and must make full monthly payments on both the principal and interest.
Since different terms govern different HELOC offerings, speak to your lender about the exact expectations you should maintain.
The biggest thing to keep in mind is that homeowners considering a HELOC need to make sure that they are prepared to meet the financial obligations related to their home equity line of credit in its different phases.
Here are eleven possible use cases for a HELOC:
HELOCs can be an empowering way to tap into your home’s equity, but you need to understand how these home loans work before pursuing one.
Borrow from yourself, not the bank!
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