Overview
For homeowners, HELOCs can be one of the best ways to borrow cash. They have low rates, they give you extended access to funds (usually 10 years), and they can even come with a tax write-off in some cases.
But not all HELOCs are created equal. Here’s what you need to know before getting a HELOC, and how to get the best deal when you do.
What’s a HELOC?
A HELOC is a home equity line of credit. It’s technically a second mortgage, meaning it’s a type of mortgage that you take out in addition to your main mortgage loan. It adds a second monthly payment to your household, too.
HELOCs use your home as collateral and allow you to borrow from your home equity, also known as the stake in the home you actually own. To calculate your home equity, you take your home’s value minus the current balance you have on your mortgage loan. So, for example, if your home is worth $500,000 and you still owe $300,000 on your loan, you have $200,000 in equity. A HELOC lets you borrow a certain percentage of that amount.
The funds are issued as a line of credit, which works much like a credit card. You withdraw money as needed for the first chunk of the loan (called the draw period), and then pay the funds back in the second part of the loan (called the repayment period).
Note: HELOCs and home equity loans are both ways to borrow from your home equity. The big difference is that HELOCs offer a line of credit you can withdraw from, while home equity loans offer a one-time lump sum. You might choose a HELOC if you want a long-term financial safety net or you need access to funds over a long period (say, for an extended renovation project).
Pros and Cons of a HELOC
The biggest advantage of a HELOC is that you can withdraw money as needed, making it a great financial safety net or tool for covering longer, more drawn-out expenses.
With HELOCs, you’ll also only pay interest on what you take out (not the full credit line), and you’ll usually have a lower interest rate than you would with other financial products, like credit cards or personal loans.
Finally, if you use HELOC funds to “buy, build, or substantially improve” your home, you may qualify for a tax write-off, too.
On the downside, HELOCs use your home as collateral, so if you don’t make payments, you could lose your house. They also often have variable rates, which can make budgeting for payments difficult, and they eat into your equity. This could be a problem if your home loses value and you need to sell.
Pros
- You can withdraw money as needed
- You only pay interest on what you withdraw
- They have lower interest rates than many other financial products
- They may qualify you for a tax write-off
Cons
- They use your home as collateral
- They often have variable interest rates
- They reduce your home equity
- They add a second monthly payment to your household
Comparing HELOC Offers
HELOCs can vary quite a bit from one lender to the next, so when considering where to get yours, it’s important you consider at least a few different companies.
You should look at:
Rates: Consider the type of rate (some companies may offer fixed rates), as well as what interest rate they’re offering you. Lower rates not only mean lower payments, but they save you more in long-term interest, too.
Fees: Always ask for a full breakdown of fees, and read the fine print, too. Look at upfront fees, as well as any ongoing fees (like annual fees or transaction fees, for instance.) There could also be prepayment penalties.
Draw/repayment periods: The standard draw period is 10 years, with a 20-year repayment term, but some lenders may diverge from this. Make sure what they’re offering matches up with your financial needs and timing.
Loan amount: How much is each lender willing to let you borrow? Keep in mind that the more you take out, the less equity you will have in your home. Make sure to only borrow what you need.
Requirements: Eligibility requirements can vary, so consider what each company requires in terms of minimum equity, debt-to-income ratio, credit score, and more. It’s possible you may qualify for one bank’s HELOC but not another’s.
Look at lender reviews and ratings, too. You will be dealing with the company for many years to come, so make sure you’re choosing one that has good customer service and a strong record of satisfaction with past borrowers.
Getting the Best HELOC Rate
The best HELOC rates are reserved for borrowers who are least at-risk of skipping payments — so those with high credit scores, a strong history of paying bills on time, and a lot of equity in their homes.
To improve your chances of getting a low rate on your HELOC, you can:
Increase your credit score
Borrow a smaller loan amount
Consider projects/updates that improve your home’s value
Reduce your other debt balances
Increase your income
Shopping around for your lender will help, too, since every lender has different pricing strategies. Your best bet is to get quotes from at least four companies. You can even use quotes from one lender to negotiate with another.
If you’re not sure how to do this on your own, talk to a mortgage broker. They can help you shop around for the best HELOC deal possible.
by your friends at The Daily Navigator
