You might be eligible to borrow against the equity you have built in your home through a home equity loan, or HELOC. HELOCs can be secured by your home, making them a popular way to borrow at lower interest rates, especially if you have high-cost needs such as home improvement, college tuition or debt consolidation.
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HELOCs can be obtained if your equity in your home is at least 20%. This may even apply to those who have not paid down their mortgage in these times of rising home values. HELOCs may have some advantages over other financing options such as credit cards and personal loans, like lower interest rates and longer loan terms. HELOCs are a type of revolving credit, and may also offer interest-only payment options. Contrary to an installment loan, HELOC borrowers can access their HELOC as long as they pay off the balance.
Before you take out what is commonly called a “second mortgage”, you need to think about how you intend to use the HELOC. Also, consider other options that won’t cost you your home.
We’ll be sharing six different uses for a HELOC in this article. We’ll also provide three options if you feel that a HELOC might not be right for you.
Is a Home Equity Line of Credit a good idea?
HELOCs are a way for homeowners to get flexible, ongoing credit access. If they meet the requirements, HELOCs may be able to provide them with much-needed, but flexible, credit. These lines of credit are a great way to have a backup source of funding in case you need it for larger projects.
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HELOCs come with fees and conditions that all borrowers should be aware. You might have to pay closing costs depending on how large your HELOC is in order to apply for your credit line. These fees could include the cost of originating, underwriting and closing your loan. Some HELOCs also have an initial restriction period that can last from a few months to a few decades. During this time, you may be subject to a prepayment penalty, early termination fee, or a prepayment penalty for closing the loan. You may be charged different fees by different lenders. Some may waive some fees entirely.
Banks often advertise HELOCs that are “no-fee”, which do not require cash to open and have no prepayment penalties. You may be eligible for targeted discounts depending on your current relationship and account balances. Some lenders also offer introductory pricing, which lowers the rate for the first few months of your HELOC being open. Do your research before you apply. Remember that even a “no fee” HELOC will charge interest.
The pros and cons of a HELOC
HELOCs offer interest-only payments which makes them a more appealing option for flexible financing. According to Casey Fleming (a Fairway Independent Mortgage Company mortgage advisor), every benefit has a downside.
Fleming says that too many people only pay the minimum amount on their HELOC. They end up spending the entire amount on their HELOC for 25 years. He recommends that you only take this route if there is a way to quickly pay off the balance.
Five Common Uses of a HELOC
A HELOC is not required to be used for only home-related expenses.
Here are some other uses for a HELOC:
- Home improvements
HELOCs can be a great option for home improvements projects where you don’t know the final cost, says Michelle Lambright Black, personal finance writer and credit expert. Construction projects can go over budget or change scope in mid-project, so you don’t want your project to end up with no money.
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- Consolidating debt
HELOCs are used by many people to consolidate high interest debt and lower monthly payments. As long as you have a plan for paying off the debt, this strategy might work.
Lambright Black says that a HELOC can help you improve your credit score. Credit bureaus do not consider HELOC utilization in credit scoring. Therefore, moving credit card debt into a HELOC may lower your credit utilization ratio. This could improve your chances of being approved for other loans with better terms and rates.
- Purchase of another property
A HELOC is a great option if you are looking to purchase a vacation home, or rental property. HELOCs can be used to save you the 30- to 60-day underwriting process.
If you can afford to cash out your HELOC, then your offer for a new home may be more attractive than other buyers. This is because it is not contingent on bank financing.
- An emergency fund backup
A good rule of thumb is to have an emergency fund that covers three to six months of expenses. Although this is ideal, most families don’t have enough money to cover emergencies. In the event of an emergency, a HELOC is a good backup plan.
- Protect your business expenses
HELOC rates are often lower than those charged for small business loans and can be used by business owners. A HELOC does not require your business to be open for more than two years before approval. However, you should be aware of the potential risks involved in investing in a business that uses your home as collateral.