Black Friday sale, vacation, or even debt consolidation, there are many things you can do with your home equity line of credit or HELOC. It might be the next available option next to personal loans, the only advantage is, you’re technically using your accumulated monthly payment for your home.
Out of its many usages, the common use of home equity credit lines is, of course, for home improvements or renovation which ultimately affects your home equity positively.
Adhering to your regular monthly payments for the house, all the more with your home equity line, can boost your credit score as it shows a streak of good financial habits. The only downside to this is that you’re putting up your home as collateral and if you can’t make your monthly payments, you might face foreclosure. Find out how to achieve a 670 credit score personal loan.
What is a Home Equity Line of Credit?
Home equity lines are somewhat similar to home equity loans in the sense that they both use your home as collateral. The only difference between them is that home equity loans provide a lump sum amount of money for your home’s equity while the other is a credit line where it depends on you how much money you will withdraw.
Compared to home equity loans, a home equity line of credit has an adjustable interest rate based on the amount you draw. Interest-only payments are also available during the draw period. The way this credit line works is similar to how credit cards work with your current home equity as the credit limit.
With this credit line, you can borrow money as high as 85 percent of your home’s appraised value less the amount you owe mortgage companies. Since this functions as a credit card, needless to say, you won’t have to pay any principal or interest if you didn’t access any funds.
Phases of Home Equity Line of Credit .
1. Draw Period
The draw point in this line of credit can go up to 10 years where you can access cash until your limit. During this period you will only make interest payments from the amount you withdrew.
As an example, a withdrawal of $40,000 at a 5 percent rate with a 10-year period will have equal monthly payments of $166.66. Once the 10 years have lapse, you will no longer be able to withdraw funds and it will not enter the repayment period.
2. Repayment Period
This period can typically last for 10 to 20 years after the draw period. During this time, the monthly payment would be consisting of the principal amount plus corresponding interest rates. When you enter this period, you will no longer be able to withdraw cash and the total amount you did access will be then your principal amount, much like paying a consolidated loan amount.
What are the Pros and Cons of Home Equity line of credit?
A financial institution that credits HELOCs could provide an Annual Percentage Rate (APR) lower or higher than other institutions. Regardless of what lender will assess your home’s market value, you need to know the basics of this line of credit.
Pros
- Easily Accessible – Unlike personal loans or other loans for that matter, your credit score is not the determining factor whether or not you can access emergency cash. You can easily get approved since you are getting a secured loan with your home as collateral.
- Controllable – Compared to a loan where you get a lump sum of cash, HELOCs provide you a drawing period where you can access cash anytime, regardless of the amount.
- Higher Credit Score – If you accomplish these interest payments on time, it will reflect on your rating which can be beneficial if you intend to get another loan in the future. It is a known fact that a good-paying habit will influence your credit score greatly.
- Fund Flexibility – The cash you can get from HELOCs is not necessarily to be used to raise your home equity. It is flexible enough to be used for debt consolidation, travel, and others. Although, utilizing this loan to further renovate or upgrade your home will surely raise its market value.
- Tax Deductible – Only interest payments that improve or raise your home equity will be subject to a tax deduction.
Cons
- Possible loss– When applying for HELOCs you’re basically putting your home at risk of foreclosure as it is being used as collateral. This is the main risk of a secured loan; to avoid this, make sure to religiously pay your monthly dues.
- Variable Interest Rates – Depending on outside factors, particularly the Federal Reserve, interest rates can go up or down unlike home equity loans that offer fixed interest rates. Despite having variable rates, HELOCs still have lower interest rates compared to loans.
- Chances of Overspending – This scenario comes more from the lack of discipline. Since during the draw period you only need to pay interest rates, the amount you will need to pay when the repayment period might catch you off guard.
What to Do Before Applying for a HELOC?
Knowing how HELOC works is not enough, you need to do some digging on different lenders that offer the services. Aside from understanding the variable interest rate, you need to carefully review the terms of your HELOC. Some HELOCs despite charging only the interest for a few years might surprise you with a lump sum amount at the end of the loan or as it is called – balloon payment.
Alternative to HELOC
1. Home Equity Loan
Home equity loans are also a type of a secured loan that uses how much equity your home has. The only difference is that instead of using a line of credit, funds are given as a lump sum. It has a set repayment period and a fixed interest rate, giving you fixed monthly payments.
Treat this as you would student loans or any other loans, know how much you need; get it, spend it, then repay it. This way you won’t have to worry about a surprise boatload of cash you need to pay after several years.
2. Cash-out Refinance
Utilizing cash-out refinance, your existing mortgage will be replaced with a new loan and a higher balance. Say your home is worth $300,000 but you currently owe mortgage brokers $100,000 – you can do a cash-out refinance with a new loan of $240,000 and get cash worth $140,000 less of course the closing costs and other refinancing fees.
Through refinancing, the majority of the lenders will let you borrow up to 80 percent of your home’s market value while giving the difference against your current mortgage in hard cash.
3. Personal Loan
Much like a home equity loan, a personal loan also has a fixed rate when it comes to its interest. The funds will also be given as a lump sum and upfront. The only difference is that personal loans have an option where you can have an unsecured loan, meaning you won’t have to put up your home as collateral.
Some personal loans can also be filled up online with funds transferred as early as one business day after approval. One more thing to note about this kind of loan is that its fixed interest rate could be a tad higher than that of HELOCs.
Lenders also offer small personal loans with funds as low as $300. This way, you won’t have to risk your home for a quick cash turnaround.
Other Things You Need to Know
1. What are the Upfront Closing Costs?
Closing costs are other expenses, aside from the price of the property itself, that are necessary to close the deal.
The usual costs that buyers and sellers produce include credit report charges, title searches, title insurance, surveys, taxes, origination fees, appraisal fees, deed recording fees, and discount points. Whatever necessary costs are added in order to complete the real estate transaction, the lender is mandated by law to show these costs in a loan estimate form within three days of the home loan application.
2. How Much Money Can You Borrow On a Home Equity Credit Line?
The amount of money that you can borrow at any given time would be dependent on your home market value.
It is usually ranged from 60 to 85 percent of your home equity or the assessed value of your home minus the balance that you owe mortgage brokers. Factors such as creditworthiness will also come into play.
To give you a rough idea, the scenario is that the total value of your home is at $450,000 yet you still owe$120,000 on the mortgage. You applied for a HELOC and got approved for 70 percent of your home equity – you will be getting a $231,000 cash that you can access anytime.
3. What is the Interest Rate?
HELOCs are always accompanied by variable interest rates, meaning their rates could vary during the entire duration of the loan.
While these rates follow the Federal Reserve, it is closely related to the prime rate or the interest rate banks charge to let you borrow money.
Since March 2020, or when the pandemic was first announced, there has been an apparent drop in banks’ prime rate – it dropped to 3.25 percent which unusually low. As comparison, the prime rate way back 2001 was at 9.05 percent. And because of this, the HELOC interest rate will follow suit.
From May of 2020 until August 2020, the interest rate for this line of credit has been in constant 4’s with the highest at 4.59 percent and the lowest at 4.29 percent. Given the fact that it changes over time, the interest rate will surely go up once the economy has started to gradually recover.
Your interest rate would also depend on what the lender allows you to access from your total market value. To give you an over view, a $50,000 loan with 80 percent loan-to-value will incur an interest rate of 4.29 percent and a $50,000 loan this time with 90 percent loan-to-value, will have an interest rate of 4.92 percent.
Takeaways
Like any other loan, HELOC has risks attached to them and with a low-interest rate, borrowers with less discipline might be at a disadvantage. It is always wise to have reserved cash rather than taking out a loan – try to consider these options:
- Open up a savings account to hold your money and make the interest rates work in your favor. In case of emergency, you will be using your saved up money and dodge the problem of debt payment obligations.
- Invest in money market accounts – they pay more than saving accounts when it comes to interests. Another good thing about money market accounts is its ability to limit how often you can make certain transfers.
- Commit to Certificate of Deposits (CDs); leaving your money untouched for a certain period of time could benefit you more when the payout comes.
Different lenders, different rates, different options, how would you know what is the best loan for you? Do your homework and sit on your decision before you commit to a loan. Make sure to get your information only from trusted financial sites.
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