Advantages of a HELOC

By Linda Johnson

  • Overview

    Advantages of a HELOC
    If you have equity in your home, meaning that some percentage of its value is not mortgaged, then you have a source of capital you may be able to tap. Banks offer Home Equity Lines of Credit (HELOC) so you can use some of the equity in your house and pay it back on your own schedule. College funds, travel, home repairs and renovations--these are some of the things people pay for out of a HELOC.
  • Advantage: Flexibility

    The advantage of a HELOC over a traditional home equity loan is that it is flexible. Instead of borrowing money in one lump sum through a conventional loan, you can borrow only what you need through your line of credit. You can pay it back as soon as you want to, without early payment penalties. For example, rather than taking out a thirty year second mortgage in order to buy new carpeting, you can just use what you need from your line of credit to cover the cost of the carpet. Then, you can pay it back in four or five installments or however long you wish, within the limits established by your bank. Next year, you can use the same equity all over again to buy new kitchen appliances, or add on a screen porch, or pay Junior's college tuition.
  • Advantage: Simplicity

    It's as simple as a credit card, but more economical. Your Home Equity Line of Credit will have a specified credit limit you can borrow against, just like a credit card. You will have a "draw" period, or basically the time span of the loan; this can be anywhere from five to 25 years. Again, just like a credit card, you pay back only what you use with interest. You will have a minimum monthly payment to make, which may be interest only. Whatever you pay beyond the minimum goes against the principal. Your minimum monthly payment will go up and down depending on how much equity you use. When the draw period ends, you have to pay the entire amount of the principal either as a lump sum or by converting it into a new amortized loan. Often this does not occur until the house is sold or refinanced.

  • Advantage: Deductibility

    An advantage of a HELOC (which also applies to traditional home equity loans) is that the interest you pay is usually tax deductible. This tax incentive makes it a much more attractive way to borrow money than going into credit card debt.
  • Advantage: Lower Interest

    You will be paying variable interest on your HELOC, based on the prime rate. Historically, that rate is comparatively low. Add that to the tax deductibility factor and a HELOC is a rather inexpensive loan. Different lenders calculate the rate in different ways. Ask each lender how the calculation is done and then make comparisons. Also, be sure to find out how much your HELOC rate can jump to if the prime rate goes up. It should have a cap on how high it can go at any one time, such as in increments of 0.5%. In the case that the prime goes down significantly, ask if you can switch to a fixed rate loan without penalty or charges.
  • Consideration: Risk

    What's the risk? Your HELOC is credit based on the equity built up in your home. If you are unable to make the payments, your home could be in jeopardy. Set up your budget factoring in the amount of each monthly payment. When you use more of your HELOQ, you have more of a minimum payment. Again, take a good look at your budget before tapping into your line of credit.
  • Consideration: Credit

    The value of your home must be established through market analysis and appraisal. Any fees for this should be rolled into your loan, or again, if you have good credit there may be no fees at all.
  • Consideration: Freeze

    Because of falling home values and the lowered prime rate, banks are a little more picky about approving HELOCs than before. They see their rate of return diminishing right along with the value of real estate. If you already have a HELOC, but real estate in your area is going down in value, your bank might want to freeze your line of credit so you can't use any more of it than you already have. One financial blog (see Resources below) suggests maxing out your line of credit now before a possible freeze. However, that could get you in way over your head. Let's say you do have less equity in your home now than when you got your HELOC--you could be at a deficit if you have to sell.
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