Should you consider a Home Equity Line of Credit (HELOC)?

If you need access to cash, there are many options to consider. Each have their pros and cons. Depending on your situation, a home equity line of credit (HELOC) may be right for you.

What is a HELOC?

A HELOC is often referred to as a “second mortgage”. If you own a home, it’s likely your most valuable asset. With a HELOC, your home is used as collateral for another loan. If you’ve lived in your home for more than a couple of years, you likely have enough equity to apply for a HELOC.

A HELOC works similar to a credit card because it provides you a credit limit from which you can take out money in increments.

How does a HELOC work?

A HELOC gives you access to a sizeable pool of cash. Borrowers can usually tap up to 80% of their home’s value, minus the remaining balance on your mortgage. Adjustments are then made based on your credit and ability to pay.

Say you have a home worth $400,000 with a balance of $250,000 on your first mortgage and you’re allowed to access up to 80% of your equity:

  • $400,000 x 80% = $320,000
  • $320,000 – $250,000 = $70,000 (your max line of credit limit)

As detailed in Forbes, most HELOCs have a variable interest rate. As baseline interest rates go up and down, so will your interest rate.

How does a HELOC differ from a home equity loan?

Unlike a HELOC, with a home equity loan, you get all the money at once. This can be a disadvantage if you don’t want all the money at one time, and you don’t want to pay interest on money you might not be using. Also, home equity loans are usually issued with a fixed interest rate.

What are the advantages of a HELOC?

  1. Flexibility: Instead of getting a lump sum, you can take out as much (up to your limit) or as little as you’d like. And you are only paying interest on what you have drawn out.
  2. Cheaper than Credit Cards: HELOCs generally have much lower rates so you save on interest charges. Rate are lower because you’re using your home as security for the loan. Therefore your lender has a much lower risk of realizing a loss if you get into financial difficulty.
  3. Tax Advantages: Interest from the loan may be tax deductible. Consult a tax adviser for information regarding the deductibility of the interest and charges.

What are the disadvantages of a HELOC?

  1. Your Home is the Collateral: While using your home may help you secure a lower rate, this also puts you at an increased risk of property loss.
  2. Potential Interest Rate Increases: Interest rates are still near historic lows. According to NerdWallet, you should be prepared for interest rates to rise over the course of your loan. All adjustable rate loans have lifetime caps. In other words, these caps indicate the highest possible rate you may be charged. If you are not confident of potentially being able to pay this rate, you might consider other alternatives.

Great Reasons to Consider a HELOC

According to the Wall Street Journal, home improvement is by far the most popular reason borrowers tap their home equity. If you have a very specific expense (like a kitchen remodel) then a home equity loan may be the right answer. But if you’re considering multiple projects over a period of time, a HELOC allows you the flexibility in accessing your cash.

HELOCs are also often used as a safety net. You may not have an immediate use for your funds, but if an emergency arises, you will be able to access it quickly.

Read the Fine Print: Critical Variables of a HELOC

  • Many consumers opt for an adjustable rate HELOC because they are often initially cheaper than fixed-rate loans. In fact, many banks offer introductory teaser rates. However, these rates often automatically rise after a few months.
  • If you use this line of credit often, it’s usually a cheaper form of borrowing, especially compared to credit cards.

Conclusion

It’s up to you to do your due diligence in determining if a HELOC is right for you. However, in general, home equity is usually used for ‘needs’, not ‘wants’. If you’re making home improvements, you’re adding value to your initial investment. On the other hand, if you use the funds on an exotic vacation, your cash could be gone quickly with little to show for it.

Terms on HELOCs can vary significantly. It’s likely worth your time to check several options. The best place to start may be a local community bank like the Bank of Southside Virginia. Most banks offer HELOCs, but with local roots, your community bank may take more time to help you understand all the variables in determining your best option.

 

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