What Is a Home Equity Line of Credit?

July 12, 2019 9:00 am What Is a Home Equity Line of Credit Published by

The world has an unpleasant tendency to be expensive. Without much effort on our part, it often seems that money just flies away no matter how hard we try to hold it. Why does this happen? Because life is composed of problems, and money is required to solve many of those problems. In this article, we will cover a risky (but effective) method that will allow you to cover those emergency expenses if you find yourself in a tight situation.

What Is A Home Equity Line Of Credit?

A home equity line of credit (or “HELOC” for short) is a special line of credit. It works somewhat like a credit account, but with one key difference: Your home or other property serves as collateral. As we said before, it is a risky tactic but an effective one.

The good part is that you can quickly obtain the money that you need. You can borrow only as much as you require, and you will only pay interest on the amount borrowed. However, this is a double-edged sword. If you default on a HELOC account, you can lose your home or property. Your lender might be willing to work out alternate arrangements with you, but they can technically foreclose on your home as soon as the loan goes into default.

It is worth noting that there isn’t much difference between a HELOC loan and a reverse mortgage. Both of them work in a similar fashion. It would be accurate to say that a HELOC loan is just a more specific type of reverse mortgage.

How Does A Home Equity Line Of Credit Work?

In order to understand a HELOC loan, you need to understand the concept of equity. Equity is just the real value of your home. To figure out exactly how much equity you have in your home, just take the market value of the home and subtract any money that you owe. This would include any outstanding debts related to the property. The number obtained will be the equity value of your home.

So, let’s say your home is worth $100,000, and you owe $30,000. With a HELOC loan, you could borrow up to $70,000. So, the important thing to ask yourself is this: If I should fall behind in payments, how long would I have before I lose my property?

To answer this question, you will have to consult your lender. HELOC loans are given a pre-determined “draw period.” During this time, funds can be withdrawn and used at any time. During the draw period, you will likely have a monthly payment. However, this payment will mostly consist of interest, and will thus be fairly low.

If you want to get a better idea about rates and terms, you can use this handy HELOC calculator to at least get a basic idea of how it works. Try this one if you’d like a second opinion.

Interest Terms

When it comes to interest payments, your lender will probably offer you several options. In most cases, you will have a choice between a fixed or variable interest rate. Thankfully, this is an easy decision to make.

To decide which kind of interest plan you want, take a look at the current prime interest rate (set by the Federal Reserve) and compare it to rates in the past. If the rate is abnormally high, go with a variable plan so that you won’t be stuck with a big interest payment. If the rate is low, go with the fixed plan so that you can keep it low.

One of the best things about HELOC loans is the fact that you can use your interest payments as a deduction. This is possible because of a provision in the Tax Cuts And Jobs Act of 2017, which allows you to get this tax write-off under one condition: You must use the money to improve your home.

Because this is a secured loan (i.e. secured by collateral), the interest rate will probably be quite low.

What Happens At The End Of The Term?

At the end of the draw period, it’s time to pay the piper. All the money you owe is due at that time. However, you may not have to come up with entire payment in one lump sum. Make sure that you work these details out with your lender before borrowing a single cent. The ideal thing is a repayment schedule rather than a lump-sum payment. Such an arrangement is much easier to accomplish and presents less risk to the borrower.

Most HELOC loans have a fairly long term, with 20-30 years being somewhat common. Short-term HELOC loans are ideal for those with only one specific need. For instance, let’s say that a storm causes your roof to collapse, and you do not have enough money for the repairs. That HELOC loan would allow you to get the money right away so that you can get the repair job started as soon as possible.

How Do I Get Approved For A HELOC Loan?

When you apply for a HELOC loan, they will probably be looking at two things: Your history and your home. They will certainly want to look into your financial history, with an emphasis on how often you pay your debts. Those with bad credit and/or large unpaid debts are unlikely to be approved.

They will also probably send an appraiser to the home in order to determine its total equity. Depending on your lender and their policies, you may be assessed a small fee for the appraisal inspection. The approval process is likely to differ among all the various financial institutions, so make sure you ask plenty of questions and get everything in writing.

Conclusion

There is no doubt that a HELOC loan can be risky. However, it can also be a lifeline that prevents disaster in the event of an unexpected expense. Although we advise caution, it should also be noted that these loans are not particularly risky.

According to this research, most of those who take out HELOC loans do not lose their property, so there’s no cause for serious fear. If you have enjoyed this article, we invite you to fill out the contact form below so that you can learn even more from our team of trusted experts.