Just like a credit card, a home equity line of credit (HELOC) is a revolving line of credit that you can use to pay for home repairs or other expenses.
Unlike a credit card, if you can’t pay for it, you can lose your home.
That’s because HELOCs are secured lines of credit that use your home equity (aka your home) as collateral.
While most people know the basics of how a credit card works, you will be forgiven if they have no idea where to start with a HELOC. And while they are often confused with home equity loans, a HELOC works differently.
If you are thinking of tapping into your home equity with a line of home equity, make sure you weigh the benefits against the potential disadvantages of this method of home financing.
What is a Home Equity Line of Credit (HELOC)?
A home equity line of credit (HELOC) is a line of credit secured by your home that you can use for anything. A HELOC is similar to a credit card in that you can spend up to your maximum credit limit. All you have to do is pay back what you spent, as opposed to a loan where you have to repay the full amount of the lump sum that you received upfront.
HELOCs traditionally operate on a 30 year model where you have a 10 year draw period to spend with your HELOC and then you have 20 years to pay off everything you spent.
Advantages and disadvantages of HELOCs
Lower interest rates than credit cards and other loans
Option to set your interest rate
Pay only for what you spend
There are no rules about what the money can be used for, but you can get a tax break on certain purchases
There are often discounted tariff offers for an introductory phase
Higher credit limit than credit cards, depending on your equity
HELOCs can be delivered with a minimum withdrawal amount
There may be restrictions on how you can access the funds
There is a set withdrawal period after which you will not be able to access any further funds
With a HELOC. fees may apply
You can violate your creditworthiness if you fail to make payments on time
It’s harder to qualify now
Lower interest rates
HELOCs have a lower interest rate than credit cards. The average interest rate for a HELOC is currently below 5%, while credit cards have an average APR of 16%.
They have floating rates, which means the interest rate fluctuates over time, but even when rates go up, they are lower than most credit cards.
Option to set your price
Some lenders offer the option to set the interest rate on your outstanding balance so that you “don’t face a rising interest rate after you’ve accumulated a balance,” said Greg McBride, senior financial analyst at Bankrate.
With rates currently low and unlikely to rise significantly for a while, there is nothing to worry about right now, says McBride.
Check your local credit unions for HELOCs, which can often offer more competitive rates.
Pay only for what you spend
As with a credit card, you only have to pay what you spend on the home equity line of credit plus interest. This is different from other home finance financing options, such as a home equity loan, which requires you to borrow and repay the entire loan amount, whether or not you have drawn it on.
Use the money for everything
Just like a credit card or personal loan, the money from your HELOC can be used for anything you want. But if you’re using it on a home project, you can get a tax break.
You can deduct any interest paid on a home loan or HELOC if it is used to buy, build, or improve the home of the taxpayer who secured the loan.
Some HELOCs come with introductory offers
Introductory offers for HELOCs are a nice perk, but you shouldn’t necessarily move to one or the other lender as they are longer-term loans. A 6-month interest discount doesn’t make that big a difference if you keep using your HELOC over the average 10-year payout period.
Your credit limit will be higher than most credit cards
Since you are securing your HELOC with what is probably your greatest asset, your home, your credit limit will likely be much higher than a standard credit card. Your exact limit will depend on how much equity you have in your home, your existing credit history, and other factors.
Minimum withdrawal amount
This option is not for you if you are looking for a new way to get on with everyday life. Most HELOCs require a minimum withdrawal of around $ 10,000, sometimes more.
There may be some hoops you have to jump through to use up the money
Make sure you check how you can access your HELOC. Some are only accessible by check, others by cards or online banking.
There is a fixed draw period
You can only access your HELOC for a certain period of time. Most HELOCs use a 30 year model where you have a 10 year draw period and a 20 year repayment period. After your draw period has expired, you will no longer be able to access your HELOC.
HELOCs can be chargeable. Annual fees, application fees, appraisal fees, attorney fees, and transaction fees can all add up. Not every HELOC account charges all of these fees, but make sure you know what fees you may incur.
They can damage your credit if you don’t use them responsibly
As with any loan, failure to make your HELOC payments on time will damage your credit score. It’s also important to remember that a HELOC is backed by your home, which means that if you default on your payments, the lender can seize your home.
It’s harder to qualify now
Lenders have tightened their qualifications for HELOCs and home equity loans due to the recession caused by the pandemic. You will need better credit and more equity in your home to qualify for a HELOC today, but there are other options as well.
Alternatives to a home equity line of credit
A HELOC is a great way to use your home’s equity for yourself, but it’s not the only way. If you don’t qualify for a HELOC, you are likely to have similar difficulties obtaining a home loan. So look at two other options:
Disbursement of mortgage refinancing
A mortgage refinance with payoff involves taking out a home loan that is greater than what you owe on a current mortgage and paying the difference in cash.
The requirements for refinancing have currently tightened somewhat, but not as much as for HELOCs and home equity loans.
A home loan works like a traditional loan that is backed by your home. You are given an upfront lump sum that you can use for whatever you want, and then you have monthly payments set up until you have paid off your debt.
With a personal loan, you get an upfront lump sum, although prices vary. As with a HELOC, you can use the funds as you wish.
You also need to have a good credit history for approval and it can be more difficult to find lenders at the moment as the credit market is tight.
A HELOC can help fund larger projects like home renovations or paying a child’s tuition fees. But they are not without risk and if you default you can seriously damage your creditworthiness and even lose your home.