When you need cash, you may want to tap into your home’s equity. One such way to do this is with a home equity line of credit. This second mortgage puts a second lien on your home, but gives you access to up to 85% of your home’s value. The amount you may borrow depends on the outstanding balance of your existing mortgage.
A line of credit gives you access to the full amount of the funds as you see fit. You can take the entire amount in one lump sum or you can have the funds placed in a bank account for you. The lender then provides you with a checkbook and/or debit card so you can fully access the funds. You may use up to the limit of your funds. During the draw period (the first 10 years), you can use the funds just as you would a credit card. As you pay the funds back, you can reuse them.
As with any loan, there are pros and cons to the home equity line of credit. We cover them below.
Pros of the Home Equity Line of Credit
First, we’ll discuss the benefits of the home equity line of credit:
- Easy access to the funds you need – All you have to do is write a check or use your debit card to gain access to the funds.
- Interest only payments – During the draw period you only need to make interest payments on the money you withdrew. For example, if you have a $100,000 line of credit but only take out $20,000, you’d only pay interest on the $20,000. The principal payments are not required until the repayment period, which is 10 years after your closing date.
- Tax deductions – You may be able to deduct the interest on your home equity line of credit from your taxes. There may be limitations regarding the amount if you did not use the funds for home improvements though. As always, discuss your options with your tax advisor first.
- Low interest rate – If you have excessive debts with high interest rates, you may be able to save money with the HELOC. Consolidating the debt into one payment can be convenient and save you money on interest over the life of the loan.
Cons of the Home Equity Line of Credit
Just like most things in life, there is a downside to taking out a home equity line of credit.
- Payment shock – If you only make interest payments during the draw period, you could be in for a shock when the draw period ends. Suddenly you will owe principal and interest on the full amount that is outstanding. You pay this off over a 20-year period, which could mean significant payments.
- Your home is at risk – Taking more equity out of your home means the bank can start a foreclosure proceeding if you miss payments. If you consolidated unsecured debt into your home, you suddenly put your home at risk even though it wasn’t necessary.
- Interest rate fluctuations – HELOCs usually have a variable interest rate tied to a major market index. It’s impossible to predict what that rate will be when the rate starts adjusting. If the rate increases dramatically, you could be at risk of being unable to make your payments.
- Home value fluctuations – It’s also impossible to predict how the value of your home will fare in the future. As the housing crisis showed, it’s possible for homes to lose hundreds of thousands of dollars in value in a short amount of time.
Before you decide if a home equity line of credit is right for you, it’s important to do your research. Most importantly, you’ll want to shop around. You’ll find hundreds of lenders that offer the programs. You’ll want the lender that offers the best interest rate, terms, and fees. Because this is not a program that Fannie Mae or Freddie Mac oversees, different lenders can have different requirements.
Before you take out a HELOC, make sure you understand the ramifications of it. Can you afford the payments? Will you pay it off in a short amount of time or will you have it for the entire term? These are things to consider when deciding if a home equity line of credit is right for you.Click to See the Latest Mortgage Rates»