If you have owned a home for a few or a lot of years, you probably have a considerable amount of equity in your property. Equity is the difference between the value of your home and the amount that you owe your lender. One of the popular things that many homeowners like to do is to tap that equity with a home equity line of credit, or HELOC, so that you can use your equity for what you like.
Current HELOC rates remain competitive with fixed 1st and 2nd mortgage products. Many lending companies are advertising no cost credit lines, but let’s not get ahead of ourselves.
The HELOC is similar to a credit card; it has a line of credit up to a certain amount. The difference is that the equity line of credit is backed by the property. If you do not pay the loan, the bank can take your home back. As long as you keep paying however, you can eventually pay down the home equity rates and use the credit again in the future. Home equity lines have many benefits that make them worth considering for some situations. Let’s take a look at some of the things you definitely won’t hate about a HELOC:
1. You Can Consolidate Debt
One of the most popular things to do with a home equity line of credit is to pay down credit card debt. If you have $30,000 of credit card debt at 18% interest, you are paying $5400 of interest per year. So, if you make minimum payments, you will take many years to pay off that debt.
If you take out a $30,000 HELOC on your home at 4%, you are paying just $1,200 per year in interest. This is a huge interest savings. You can use the $30,000 from the second mortgage to pay off the credit card, and your payments will be much less. Remember of course that the loan is secured by the home, so if you do not pay the loan, you will lose your home.
2. Is Interest Tax Deductible?
When you are paying that high interest on your credit card, the big monthly payment is not the only problem. You also are not able to tax deduct the interest that you are paying. With a home equity line of credit, you should be able to tax deduct most or all of the interest that you are paying each year at tax time. This will help you to save a good amount on your taxes. The laws change frequently so look up the latest home equity rules for tax deductibility.
3. Improved Credit
If you take out a home equity line of credit and you make payments on it regularly, you should see your credit score go up over time. It helps if you do not max out the credit limit. Credit bureaus like to see a nice mix of credit on your credit report, so if you have regular payments on your mortgage, HELOC, car payment and maybe a credit card, this should help to drive up your score. This will allow you to qualify for the very best interest rates for other credit accounts.
4. Embrace Flexibility
When you get a HELOC, you will get a line of credit up to a certain amount. You do not need to take it all out at once; you don’t need to take it all out anyway. You will be able to take money out as you need it, just like a credit card, except the HELOC is backed by your home.
A home equity line is nice because you can just take out money as you need it, so you only are paying interest on the money that you are using. This type of loan can be appropriate for a home renovation for example; you can take the money out as the renovation continues.
5. Seek Competitive Interest Rates
Because the HELOC is backed by your home, you will enjoy a much lower interest rate than you ever could get on a credit card. This makes your monthly payment much more affordable. Even better, some lenders, may offer a super low introductory rate on your HELOC for the first six months or year. Don’t forget to find out if you are eligible for a no cost HELOC. You also need to check with trusted lenders for today’s HELOC rates.
More Credit Line Considerations
HELOCs are not for everyone and every situation. Below are some things to think about before you get your home equity line of credit:
Most consumers get an adjustable rate HELOC because the introductory rate for the draw period is lower. But if we enter a period where interest rates rise, you could end up with your rate going higher than you thought. Also, after the draw period ends on the HELOC loan, usually after five or ten years, your interest rate will go up. You are only paying interest during the draw period; after that, you are paying principle and interest.
Unlike a credit card, you do have to pay closing costs on your new loan. You should expect you will have to pay 1-2% of the loan amount at the very least. It still may be worth doing the HELOC loan, if you have a good reason to borrow the money, but remember that you will have that upfront cost to deal with. We continue to hear about no cost HELOC loans, but clearly not every borrower is eligible for the no closing cost programs.
Debt Consolidation Risk
We mentioned debt consolidation as a benefit earlier, and it can be. You can greatly reduce the interest rate that you are paying on your debt by paying off your credit cards with a home equity line of credit. However, you need to have some self discipline if you choose this route. If you use the HELOC as a chance to run up another $30,000 of credit debt, you really are shooting yourself in the foot. Now you have $30,000 of credit card debt again, AND a $30,000 HELOC that is backed by your home.
This is how many people can and do get into financial trouble. So use caution when you are using a HELOC for debt consolidation. Sometimes homeowners will be better off choosing a fixed home equity loan, because they carry a fixed interest rate with set terms. (ie. 180 payments on a 15 year loan or 240 payments on a 20-year loan) We like HELOCs because they are a low interest way to tap your equity for important things, such as a college education or a home improvement. Just be sure that you are taking the money out of your home for a good reason. You will be paying on that loan for years, so be certain the use of the money is a good one!
Getting a HELOC is a fantastic way to use your equity in a way that pays you back. We recommend pulling out cash to invest in real estate, or to fix up your home and increase its value.
HELOCs are much more common now than they were just a few years ago. With more lenders getting back into the home equity line of credit game, you should be able to shop around and find lower HELOC rates.