Of all of the mortgage products on the market, today we’ll talk about a Home Equity Line of Credit or HELOC – what is, how it works, benefits vs. drawbacks and if it would be right for you.
What is a HELOC?
A HELOC is a revolving line of credit that your home secures. Think of it a cross between a credit card and mortgage, only with a lower interest rate because your home secures the underlying debt. An additional benefit is since the debt is secured by your home, the interest is tax deductible.
How Does a HELOC Work?
A HELOC works like a credit card, in the sense that you can charge the loan up, pay it off, then use it again. They are normally in the form of a 2nd mortgage. The interest rate is normally tied to the Prime Lending Rate plus a factor based on credit score and equity position. Like a credit card, there is close to an “interest only” payment for period during the revolving period before the loan will adjust to fully amortize so the lender can get its money back.
For example, John in St. Louis wants to get some new windows, and a deck at a cost of approximately $10,000.
His options are to: sell stock, or refinance his first mortgage and add the cash needed. The rate on the HELOC is 4.5% so the payment would be $38(10,000*.045/12).
John can take $10,000 from his HELOC and not sell stock, or have to refinance his home to pull the $10,000 out. Further, if John would like a new roof in another 3 years, the line would be there again for him to draw on.
What Could the Drawbacks Be?
Interest rates on HELOCs are adjustable so they are not fixed, like I mentioned above, they are normally tied to the Prime Lending Rate so they payment can legally change as interest rates change. In addition, like access to all debt, comes the potential to spend beyond ones means.
HELOCs are also tough to qualify for. Due to the adjustable rate and revolving nature of the contract, a high credit score is required and a considerable equity is needed.
To conclude, a HELOC is a helpful financial instrument, but they are meant for people in stable financial and equity positions.