A HELOC is a useful tool when used responsibly. But when a HELOC is abused, it can create a monster challenging to overcome.
What is a HELOC?
A Home Equity Line of Credit(Opens in a new Window), or HELOC, is a line of credit. It is similar to a credit card, but is secured by the equity in your home. Equity is the difference in the value of the home verses what is still owed on it.
If a home is valued at $150,000 and the homeowner still owes $90,000, the equity in the home is $60,000. In this case, the homeowners may be eligible for a home equity line of credit for $60,000 or less, depending on a few additional factors. They can then borrow against the credit limit at any time during the term of the loan, generally 10 years. The homeowner then pays back the funds borrowed with interest.
HELOC interest rates tend to be less than most credit cards, but is variable and can change daily. HELOCs offer flexibility and can be a great resource. The key is to pay more than the minimum payment due. The minimum payment due on a HELOC is the interest due and no principal. The key to using a HELOC responsibly is to determine if you can pay back the full principal balance and interest in a relatively short amount of time, before the loan matures or sooner.
How are HELOCs used?
Homeowners use HELOCs for everything from home repairs, purchasing a vehicle, unexpected medical expenses, vacations, flipping houses, and more.
You have an expensive car repair and do not have the funds saved for the repair. You know you will have enough money when you receive your annual work bonus at the end of the year. You borrow the funds required from your home equity line of credit. You make the required interest payment each month until you receive your annual bonus when you pay the entire remaining principal balance and interest due.
What risks are involved?
Discipline in paying down the principal and interest balance due is a must to avoid a HELOC monster. The risk if you cannot pay the entire balance at loan maturity is severe. A homeowner could lose the house to foreclosure or be required to roll it over into another HELOC or other loan resulting in thousands of dollars more in interest
Are there alternative options?
HELOCs are convenient to use, but sometimes another type of loan is better. A personal loan may be better for a much-needed vacation. A second mortgage may be a better fit for a $20,000 kitchen remodel. These loans offer lower interest rates and a regimented repayment plan to pay down both the principal balance and interest throughout the entire loan term.
Is a HELOC right for me?
The best way to determine if a HELOC is a good option is to create a list of your needs, home value, and all your questions. Include questions about interest rates, terms, long-term risks and benefits, costs involved, and alternative options.