What is a Home Equity Line of Credit and How Can It Help Me?
Sometimes you need some extra cash—whether it’s for contributing toward your child’s college tuition, paying off credit cards or medical bills, remodeling your home or taking that dream vacation. If you’re a homeowner and you need some extra funds to cover expenses, there’s a solution you may not have considered—a Home Equity Line of Credit (HELOC).
What is a HELOC?
A HELOC is a type of home loan—often with an adjustable rate—that gives you, as the borrower/homeowner, access to a line of credit determined by the lender from the value or equity in your home. While a HELOC is commonly referred to as a second mortgage, it can be issued as a primary loan. See the difference between a cash-out refinance vs a HELOC loan.
For a better understanding of how a HELOC works, think of it like a credit card in the sense that you have a line of credit that you can access for your expenditures. You will have to pay back what you owe with interest, but you can come back and withdraw as much as you need with separate transactions up to a certain point depending on the terms of the HELOC. It is ultimately up to you how much you want to withdraw from your line of credit or if you want to withdraw any funds at all.
Draw period and repayment period
A HELOC has a draw period and a repayment period. The draw period can vary but is often between 5-10 years. During the draw period, you can borrow from the credit line and minimum payments are often interest only, but you can also make payments on the principal loan balance as well.
During the repayment period (which also can vary, but is often 10-20 years), you can no longer borrow against the credit line. Instead, it's time to pay back what you owe back with monthly payments consisting of the principal and the interest of the loan.
A Variety of Options
Fixed-rate HELOC: The interest rate will not change through the life of the loan allowing you to lock in a stable rate without worrying that it will go up. Both the interest and principal must be paid off during the term of the fixed rate loan.
Adjustable-rate HELOC: The interest rate can rise or fall monthly, depending on the market industry rate. This loan rate is initially lower than the fixed-rate HELOC. You pay only interest during the draw period (usually 10 years). After this period, you are required to pay the interest and the principal.
Hybrid HELOC: This option allows you to convert a portion or all of the loan from a variable into a fixed-rate loan without having to reapply for the loan. A term would need to be chosen for paying back the fixed-rate portion.
A HELOC can help you with:
Debt consolidation: A HELOC offers the opportunity to consolidate all your credit card balances into a single loan, making it easier to manage and possible to start paying off any higher interest debts at a potentially lower rate.
Financial flexibility: By drawing upon only the funds that you need, you pay interest on just the portion of the credit line you use vs. paying more interest on one large lump sum.
Lower interest rates: Though the rate can vary over time (in the case of an adjustable rate HELOC), HELOCs generally offer lower rates than many credit cards and personal loans.
Tax benefits: For borrowers who itemize on their tax returns, a HELOC offers potential tax advantages if certain requirements are met. Single borrowers can potentially deduct interest up to the first $50,000 borrowed, while couples who file jointly can deduct up to $100,000 if the HELOC was used to “buy, build or substantially improve” their home. For more information, consult your tax advisor.
Limits on rate increases: If you have an adjustable-rate HELOC, the interest rate can fluctuate, but will have a maximum cap on how high the interest rate can increase for your protection.
Credit limits: HELOCs may provide access to a much larger line of credit than many credit cards. (Again, the amount you can borrow is determined by the equity in your home.)
Use it as you’d like: While some loans specify what the funds can be used for, a HELOC has no such requirements, allowing you the freedom to spend as you wish. (However, since the loan is backed by your home, it’s best to spend wisely.)
A New American Funding loan officer can help explain more about what a HELOC has to offer you and help determine if this is the right loan option for your financial situation. Give us a call today!