If you’re looking for money to use for a home improvement project to consolidate bills, finance higher education, a new home business or to make a major purchase, consider tapping into your home’s equity.
One great way to do this is by opening a home equity line of credit, or a HELOC. Let’s take a closer look at HELOCs and why they can be an excellent option for homeowners in today’s financial climate.
Here are five frequently asked questions about HELOCs:
What is a HELOC?
A HELOC is a revolving credit line allowing homeowners to borrow money against the equity in their home. The HELOC is like a second mortgage on a home; if the borrower owns the entire home, the HELOC is a primary mortgage.
A HELOC is a line of credit and not a fixed loan, so borrowers can withdraw money from the HELOC as needed rather than borrowing one lump sum. This allows for more freedom than a loan and is especially beneficial for borrowers who don’t know exactly how much money they’ll ultimately need to fund their venture.
Repayment of HELOCs varies, but is usually very flexible.
Many lenders collect interest-only payments during an initial “draw” period, with principal payments being strictly optional. Others require ongoing monthly payment toward both principal and interest.
When the draw period ends, some lenders will allow borrowers to renew the credit line and continue withdrawing money. Other lenders require borrowers to pay back the entire balance due, also known as a “balloon payment.” Still others allow borrowers to pay back the loan in monthly installments over another set amount of time, known as the “repayment period.” Repayment periods are usually generous, lasting as long as 20 years.
How can borrowers spend the money?
While home improvement projects are popular uses for HELOCs, borrowers are free to spend the money however they please. Some other uses for HELOCs include debt consolidation, funding a wedding, adoption, dream vacation or the launch of a new business.
Is everyone eligible for a HELOC?
Like every loan and line of credit, HELOCs have eligibility requirements, which help lenders determine the applicant’s financial wellness and responsibility. Most notably, the borrower must have a minimal amount of equity in the home and a good credit score.
How much can I borrow with a HELOC?
HELOC amounts vary along with three criteria: the value of your home, the percentage of that value the lender allows you to borrow against and the outstanding amount on an existing mortgage.
To illustrate, if you have a $300,000 home with a mortgage balance of $175,000 and your lender allows you to borrow against 85% of your home’s value, multiply your home’s value by 85%, or 0.85. This will give you $255,000. Subtract the amount you still owe on your mortgage ($175,000), and you’ll have the maximum amount you can borrow using a HELOC, which is $80,000.
What are the disadvantages of a HELOC?
A HELOC is secured by your home’s equity, which places your home at risk of foreclosure if the HELOC is not repaid. Before opening a HELOC, it’s a good idea to run the numbers to get an idea of what your monthly payments will look like and whether you can easily afford to meet them.
Also, many lenders require the full payment of the HELOC after the draw period is over. This can prove to be challenging for many borrowers.
Finally, if you don’t plan to stay in your home for long, a HELOC may not be the right choice for you. When you sell your home, you’ll need to pay off the full balance of the HELOC. You may also need to pay a cancellation fee to the lender.
A HELOC can be a great option now
HELOCs typically have a variable interest rate, which means the interest on the loan can fluctuate over the life of the loan. Although COVID-19 may impact the economy for months, or years, to come; there is a silver lining: historically low interest rates. The average APR for fixed 30-year mortgages has hovered at 3% for months now, and some experts predict it may continue falling. The low rates make it an excellent time to take out a HELOC with manageable payback terms.
The economic uncertainty the pandemic has generated also makes it a good time to have access to extra cash for any need that may arise.
You can learn much more about HELOCs at our June 23 webinar, "Home Equity Loans: Putting Your Home to Work for You"! In this webinar, we will discuss how to calculate your equity, the types of equity loans available, and we will walk you through the application process. Make plans to join us at 10 a.m. for this free educational event.
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