Today we are going to answer the question, “what is a HELOC and why do you need one?” A HELOC, or Home Equity Line of Credit, is a powerful financial tool that lets you tap into the equity in your home. Whether you’re looking to consolidate debt, pay for home improvements, or manage unexpected expenses, a it can help you lower your overall cost of debt, but only if you manage it responsibly.

HELOC Defined:

A HELOC is a mortgage on your property. Unlike credit cards, which are unsecured, it requires you to pledge your house as collateral. This means the loan is secured by a lien on your home, which puts your property at risk if payments are not made.

This option can serve as either a first or second mortgage. For example, if you already have a mortgage on your home, the HELOC acts as a second mortgage. But if your home is paid off, it can serve as a first mortgage. Typically, you’ll qualify for more funds if it’s in the first position.

How Does a HELOC Work?

A HELOC functions much like a credit card. You are approved for a maximum line of credit—for example, $50,000. During the draw period (usually 10 years), you can borrow from this amount as needed. If you take out $10,000, you still have $40,000 available. Once you pay down the balance, those funds become available again.

After the draw period ends, the HELOC enters the paydown period. At this point, you can no longer borrow, and the remaining balance converts to a fixed loan with regular payments.

Example of HELOC Payments:

Payments during the draw period are interest-only. For instance, if you borrow $10,000 from a $50,000 line of credit at an 8% interest rate, your monthly payment would be approximately $67. By contrast, credit cards often require payments three times as high, just in interest! This makes HELOCs a more cost-effective way to manage debt.

5 Benefits:

1. Lower Interest Rates: HELOCs generally have lower rates than credit cards. For example, transferring $10,000 in credit card debt to a HELOC could reduce your interest cost from $2,400 annually to just $800.
2. Low Closing Costs: Unlike a full refinance, which can cost $6,000 to $12,000, a HELOC often has closing costs of less than $400 when working with credit unions or banks.
3. Flexibility: Use your HELOC for anything, home improvements, debt consolidation, or even a vacation. The draw period allows you to borrow and repay funds repeatedly.
4. Access to Cash: HELOCs let you transfer funds directly to your bank account. For example, if you need to pay a contractor in cash, you can easily move money from your HELOC.
5. Customizable Payments: During the draw period, you can choose to make interest-only payments or pay extra to reduce your balance faster. This flexibility can help you manage your finances more effectively.

3 Drawbacks:

1. Risk to Your Home: Since a HELOC is secured by your property, failing to make payments could lead to foreclosure.
2. Variable Interest Rates: Most HELOCs have variable rates tied to the prime rate. If rates rise, your payments will increase.
3. Ease of Access: While the ability to borrow easily is a benefit, it can also be a drawback if you’re tempted to overspend.

Qualifications:

Your credit score plays a big role in qualifying for a HELOC. For instance, someone with a 780 score may qualify for a higher loan amount and a better rate than someone with a 680 score. Lenders will also evaluate your income, loan-to-value ratio, and how you plan to use the funds.

For example, using the HELOC for home improvements may make lenders more favorable, as these improvements increase the property’s value.

Where to Get a HELOC:

Local and national credit unions often provide the best rates and lowest closing costs. For instance, some credit unions waive fees if you keep the HELOC open for a few years. Compare offers from multiple lenders to find the best deal, focusing on the margin, the amount added to the prime rate. A lower margin or even a negative margin can save you thousands.

Get Started Today:

A HELOC is a fantastic tool when used responsibly. By lowering your debt costs, you can free up money for other areas of your life. Whether it’s consolidating credit card debt or funding home improvements, a HELOC can help you take control of your finances. Explore your options, shop for the best rates, and make your money work harder for you!

Contact us today to find out more about HELOCs and how they can help you take control of your debt!

Watch our most recent video to find out more about: What Is a HELOC and Why Do You Need One?