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A home equity line of credit, or HELOCoffers homeowners flexible access to a renewable source of funds on the equity they have built in their homes.
HELOC They tend to have lower interest rates than other types of mortgage loans. They can be a good option to finance an important expense such as a home renovationto consolidate debt or to cover an unexpected emergency.
There is Benefits of using a HELOC, particularly because you can borrow against your line of credit at any time. But one notable disadvantage is that you must put up your home as collateral to secure your loan, meaning you could lose your property if you can’t pay it back.
A HELOC may or may not make sense depending on your personal financial situation. Here are the pros and cons of borrowing against your home equity with a HELOC.
What is a HELOC?
A HELOC is a mortgage loan that allows you to take advantage the value of your home and access cash at a relatively low interest rate. HELOCs are revolving lines of credit that work similarly to credit cards, allowing you to withdraw money up to your line of credit during your term. drawing period (normally 10 years).
The most common uses of a HELOC are for home improvements, debt consolidation, or other major expenses. However, as long as you have a clear purpose and payment strategy, there is no shortage of ways to tap into your home equity.
To qualify for HELOC loan approval, you typically need to have:
- At least 15% to 20% of the equity accumulated in your home
- A good credit score (most lenders prefer a score of at least 700, but some may qualify you with a score as low as 620)
- Verifiable income
- A debt-to-income ratio of 43% or less
Advantages of a HELOC
HELOCs tend to have lower interest rates than other types of loans because they are secured by your home. They are also popular for their flexibility: you can withdraw money as needed over a 10-year period. HELOCs can be beneficial when you want money for a long-term project but are unsure of the exact amount you need.
Low interest rates
HELOCs typically have lower interest rates than other home loans, personal loans, or credit cards. Secure the lowest possible interest rate will help you save tens of thousands of dollars over the life of your loan.
During your drawing period, you can do interest only payments on your HELOC, meaning you won’t have to start repaying the principal balance of the loan until the draw period ends. Also, it is not necessary to withdraw all the money at once. You pay interest only on the amount you have withdrawn and not on your entire loan, helping you save significantly on interest.
Long withdrawal and payment periods
Being able to withdraw money continuously over a 10-year withdrawal period is a big advantage of a HELOC, especially because you can make interest-only payments until your repayment period begins. That gives you flexibility in how you use your loan and gives you time to plan ahead for when you’ll need to start making payments on the principal balance plus interest.
Cons of a HELOC
The most obvious disadvantage of a HELOC is that it is necessary use your house as collateral to secure your loan. currently environment of growing interestThe fact that HELOCs have variable interest rates is also less advantageous, since the Federal Reserve has indicated that it will need keep interest rates higher for longer.
Variable interest rates
Unlike home equity loans or a cash out refinance, which are fixed-rate loans, HELOC rates rise and fall depending on macroeconomic factors such as inflation and job growth. HELOC rates were around 3% at the beginning of 2022, but have now surpassed the 9% mark. If you’re concerned about rate volatility, a home equity loan may be a better option.
Your house is collateral for the loan.
The reason banks and lenders can offer you lower interest rates on your HELOC is because your home serves as collateral for the loan. That means it’s less of a risk for them because they can repossess your property if you default on your HELOC. However, most banks and lenders are usually willing to work with you to help you find ways to support your loan, as it is also in their best interest to continue receiving your payments.
Higher payments during the amortization period
While the cost of a HELOC is relatively low during the draw period, the repayment period can be a shock, especially in a rising rate environment. It’s important to consider how you will pay both the interest and principal of your loan before you commit to borrowing with a HELOC.
Although it will vary depending on the lender and the specific terms of your loan, many lenders require you to make minimum withdrawals from your HELOC. That means you’ll have to pay interest on those funds even if you don’t end up using them, costing you more money in interest over time.
How to Calculate Your Home Equity
To calculate your home equity, start by identifying the current value of your home. Even if you bought your home at a lower price years ago, your home equity It is based on its current value. Most lenders will require an updated home appraisal by a professional to accurately determine the current value of your home.
Popular sites like Zillow or Redfin have home price estimators you can use. They are not the most precise, but they can give you an approximate figure.
Once you know the current value of your home, determine the outstanding balance on your mortgage and subtract it from the value. For this example, if your home is worth $400,000 and you have $200,000 left on your mortgage, that means you have $200,000 equity, or 50% equity, in your home.
The equity in your home will change over time depending on the total amount of mortgage payments you have made, as well as fluctuations in the value of the property. It’s a good idea to periodically reassess your home’s market value and mortgage balance to keep track of your home’s equity.