Homeowners who need cash often turn to their own home to fund their needs. One way to do this is to refinance your first mortgage and take out cash; this is referred to as a cash out refinance. But what if you are happy with your current interest rate and do not want to refinance your home? Your best option is a home equity line of credit, or HELOC.
In most lending circles, a HELOC is considered a 2nd lien on your home. It is a line of credit based upon the equity in the property. The home equity line of credit is secured by the property so you can usually get a low interest rate on this type of loan. The only downside on a HELOC is you can lose your home if you do not pay the loan.
In some cases, a HELOC can give you access up to approximately 85% of the value of the home, minus what you owe on it. The amount you can borrow also is affected by your credit score and your income.
Does the Home Equity Line of Credit Work Like a Credit Card?
Let’s assume you have a $500,000 house with a $300,000 balance on the first mortgage. The lender will allow you to access 85% of the value. So, you can access up to $425,000, minus the $300,000 you owe, or $125,000.
Remember that HELOCs have an interest rate that can change. So, as the baseline interest rate increases and decreases over time, so can your rate. To set this rate, the lender starts usually with the prime or LIBOR rate, and then adds a markup based upon your credit score. A variable rate means you can end up paying a lot more on the loan down the road. So, you should keep this in mind. If your income falls, you could have trouble making payments and keeping your home.
When a HELOC Makes a Lot of Sense
Many homeowners like to use a HELOC as a low interest way to make repairs and upgrades to their home. When you make certain repairs on the property, the value of the home will be increased. Popular upgrades are windows, kitchens and bathrooms; these, if done affordably and within reason, can add substantial value to the property. Beware of using a HELOC to pay for things that do not pay you back, such as cars and vacations. These types of expenditures are how people got in financial trouble in the financial crash.
Should You Get a HELOC or Home Equity Loan?
A HELOC provides you flexibility of tapping equity in your home in the amount you need. You are approved up to a certain credit line, say, $50,000, but you do not have to use all of it at once, or even ever if you choose not to. You will only pay interest on the amount that you take out.
Another option is to get a home equity loan. This type of second mortgage gives you a lump of cash all at once. If you need all the cash at once for a big expenditure, you may consider this option. You will pay interest on the entire amount with a home equity loan. It features fixed interest payments over the entire loan term. You will know exactly what you are paying each month and when the loan is paid off. The home equity line is more variable.
In the past, homeowners cherished home equity financing, because it was tax deductible. In 2018, we have seen many revisions to the tax codes for deducting interest on mortgages and credit lines. According to the RefiGuide.org, there are still tax deductions available to homeowners if they are using the funds of a HELOC for home improvement purposes. References: https://www.refiguide.org/guide-heloc-loans/ and https://www.irs.gov/publications/p936
Where Can I Obtain a HELOC Loan with a Reasonable Interest Rate and No Annual Fee?
Whether you get a HELOC or home equity installment loan, the best rates go to people with good incomes and credit scores. Also, the more you shop around, the better off you will be. It is smart to check your bank; you could get a discount as a current customer. A credit union can be a good deal too, especially if you are a member. Check with a standard mortgage broker too, who has access to many types of loans. In 2018, the average mortgage lender or broker is unlikely to offer home equity products like they did ten years ago. There are style specialty mortgage companies that offer home equity lines without excessive closing costs or annual fees, so look around.
If you are getting a credit line secure by your home, you may be tempted by low rate, introductory offers. Be aware those low rates only last a few months to a year or so, and then can go up based upon market conditions.
A HELOC can be an excellent source of low interest cash for things you need. The interest rate on the loan is low at first but can go up over time. If you put that money back into your home with improvements, you really can make out well when you sell the property.
But remember that people got in trouble with credit lines in the last financial crisis. They overspent on things they did not need with money from their home, interest rate rose, and they defaulted. You do not want this to happen to you. So, use your home equity wisely on things that give you a solid return on your money.