Even with the range of financing options available today, homeowners have a unique advantage.
After you build up enough equity in your home, you may be able to borrow against that amount through a home equity line of credit, or HELOC. Since HELOCs are secured by an asset (your home), they are one of the most popular ways to borrow at lower interest rates, especially when you face high costs for household needs. such as home improvement, tuition or debt consolidation.
HELOCs are generally easy to get if you already have at least 15% to 20% equity in your home, and may offer some advantages – like lower interest rates or longer loan terms – compared to other HELOCs. other forms of financing such as personal loans and credit cards. A type of revolving line of credit, a HELOC can also offer interest-only payments. And unlike an installment loan, borrowers can access their HELOC over and over again as they pay off the balance (much like a credit card).
But before you take out what’s often called a “second mortgage,” you need to think about exactly how you plan to use a HELOC, and consider a few alternatives that won’t put your home at risk.
In this article, we will share six ideas on using a HELOC. Plus, we’ll offer you three alternatives if you decide a HELOC isn’t right for you.
Is a home equity line of credit a good idea for me?
HELOCs can give homeowners flexible, much-needed access to credit on an ongoing, revolving basis, if they can meet the requirements. Once established, these lines of credit can serve as a useful emergency funding pool for projects that exceed your daily budget.
That said, HELOCs have fees and terms that every borrower should be aware of. Depending on the size of your HELOC, you may encounter closing costs for applying for and using your line of credit. These fees may include the costs of issuing, underwriting, closing and registering your loan. Additionally, some HELOCs have initial restriction periods, lasting from a few months to a few years, during which you may be charged a prepayment penalty or early termination fee for repaying the loan or closing your loan. the line of credit. Different lenders may charge different fees, and some may even waive certain fees altogether, so be sure to ask your lender exactly what you will pay.
Be sure to shop around with multiple lenders to ensure you get the best deal. Don’t just look at the rates either; be sure to also review the fees and total cost of borrowing.
Banks typically advertise “no-fee” HELOCs that require no money to open and have no prepayment penalties. Your bank may offer targeted discounts based on your existing relationship and account balances. Additionally, some lenders offer introductory prices that further reduce the rate for the first few months your HELOC is open. Research thoroughly before applying – and remember that even a “no-fee” HELOC will at least charge interest.
Advantages and disadvantages of a HELOC
Notably, HELOCs are known to offer interest-only payments, making them an even more attractive option for flexible financing. However, with every benefit comes a caveat, according to Casey Fleming, a mortgage consultant for Fairway Independent Mortgage Company.
“Too many people are just paying the minimum payment on their HELOC,” says Fleming. “They end up paying for this shopping spree for the next 25 years. Only go this route if you have a plan to pay off the balance quickly,” he says.
Here are some additional pros and cons of purchasing a HELOC:
May offer interest-only payments for the first year(s)
Can allow borrowers to access revolving credit worth up to a certain percentage of the value of their home (usually 85%)
Interest may be tax deductible if the funds are used to improve the value of your home
Can be used as you wish
Interest-only payments require extra discipline and can encourage spending beyond your means
Could charge closing costs, like on a primary mortgage (but not always)
You generally need at least 15% to 20% equity in your home to qualify
Failure to repay could result in foreclosure of your home
5 common uses of a HELOC
You don’t have to use a HELOC just for home-related expenses.
If you’re wondering what else you can use a HELOC for, here are some options:
HELOCs are “especially useful for home improvement projects when you don’t know what the final cost will be,” says Michelle Lambright Black, credit expert and personal finance writer. Construction projects are notorious for going over budget or changing scope midway through, and you don’t want to run out of money before your project is complete.
Many people use HELOCs to consolidate high-interest debt and lower their monthly payments. This strategy can work, as long as you have an ultimate plan to pay off the debt.
According to Lambright Black, a “hidden benefit” of using a HELOC to pay off credit card debt is that it can improve your credit score. Credit reporting agencies do not consider HELOC usage in credit scoring, so transferring credit card debt to a HELOC could lower your reported credit utilization ratio. Such an increase in your score could help you qualify for better rates and terms on other loans.
Buy another property
If you want to buy a vacation home or rental property, a HELOC can simplify the process. Assuming the equity in your home is comparable to the cost of another, using HELOCs as opposed to a traditional mortgage could help you avoid the typical 30-60 day underwriting process.
Assuming you can afford to “cash in” your HELOC, your offer on a new home might be considered stronger than that of competing buyers because it wouldn’t rely on bank financing.
A relief emergency fund
The general rule is that you should have an emergency fund that covers three to six months of expenses. While that’s ideal, the reality is that most families don’t have as much on hand for emergencies. A HELOC can serve as a backup to your emergency fund in case the unexpected happens.
Cover business expenses
Business owners can often use a HELOC with lower rates than charged on a small business loan. Additionally, a HELOC does not require your business to be open for two years before being approved, as most small business loans do. The HELOC can be used to start a new business, cover current expenses, or expand an existing business. But be aware of the risks associated with investing in a business using your home as collateral.
Home Equity Line of Credit (HELOC) Alternatives
If you need financing but don’t think a HELOC is the best option for you, here are some other ways to get the financing you need:
Refinancing by collection
With interest rates nearing historic lows, refinancing your existing mortgage in cash can guarantee you low rates for the next 15 to 30 years. According to Fleming, a cash-out refinance “is a good idea if your current mortgage doesn’t have a low interest rate.” And, because a traditional mortgage payment includes both principal and interest, your balance decreases with each payment. In comparison, payments on an interest-only HELOC during the draw period would not reduce your principal balance.
Credit card 0% APR promotion
Many credit cards offer an interest-free promotional period when you first open the account. These 0% APR promotions can be used for purchases, balance transfers, or sometimes both. Some of these promotions can last up to 18 months or more. Although some banks charge a balance transfer fee of 3% to 5%, they generally do not charge a fee on purchase promotions.
“These offers are a good idea if you can pay off the balance before the promotion expires,” says Lambright Black.
Personal loan or line of credit
Although personal loans or personal lines of credit may have a higher interest rate, they can usually be opened very quickly. In some cases, borrowers can see money in the bank account the same day they apply.
Meanwhile, most HELOCs require an assessment and it can take a few weeks for the application to be approved. Not to mention that HELOCs sometimes require you to keep the line of credit open for at least a few years. Therefore, if you need money quickly for a specific purpose (and plan to pay it back quickly), personal loans may be preferable in this scenario.