Even with the financing options available today, homeowners have a unique advantage.
Once you have created enough equity in your home, you may be able to borrow against that amount through a home equity or HELOC line of credit. Because HELOCs are secured by an asset (your home), they are one of the most popular ways to borrow at lower interest rates – especially when you are facing high costs for needs such as home improvements, college tuition or debt consolidation.
HELOCs are generally easy to obtain if you already have at least 15% to 20% equity in your home and can offer some benefits – such as lower interest rates or higher loan terms – over other forms of financing, such as personal loans and credit cards. A type of renewable credit line, HELOC can also offer interest-only payments. And unlike an installment loan, borrowers can access their HELOC over and over again as they pay the balance (like a credit card).
But before you remove what is often referred to as “second mortgage”, you’ll want to think about exactly how you plan to use a HELOC, as well as some alternatives that will not put your home at risk.
In this article, we will share six ideas on what a HELOC can be used for. In addition, we will provide three alternatives if you decide that HELOC is not for you.
Is a home equity line of credit a good idea for me?
HELOCs can provide homeowners with the necessary and flexible access to credit on an ongoing, recyclable basis if they can meet the requirements. Once established, these credit lines can serve as a useful back-up for projects that exceed your daily budget.
That said, HELOCs have commissions and terms that every borrower should be aware of. Depending on the size of your HELOC, you may incur closing costs to apply and use your credit line. These commissions may include costs for setting up, sponsoring, closing and registering your loan. In addition, some HELOCs have initial restraint periods, ranging from a few months to a few years, during which you could be charged a prepayment penalty or early termination fee to repay the loan or close the credit line. Different lenders may charge different fees and some may even waive some fees altogether, so be sure to ask your lender exactly what you will pay.
Make sure you buy from multiple lenders to make sure you have the best deal. Don’t just look at the percentages, either; make sure you also consider the commissions and the total cost of borrowing.
Banks usually advertise “fee free” HELOCs that do not require cash to open and come with no prepayment penalties. Your bank can offer targeted discounts based on your existing relationship and account balances. In addition, some lenders offer introductory rates that lower interest rates during the first few months that your HELOC is open. Research thoroughly before applying – and remember that even a “free” HELOC will charge at least interest.
Advantages and disadvantages of a HELOC
In particular, HELOCs are known for offering interest-only payments, which makes them an even more attractive option for flexible financing. However, every benefit comes with a warning, according to Casey Fleming, a mortgage consultant. Fairway Independent Mortgage Company.
“Too many people just pay the minimum payment on their HELOC,” says Fleming. “They end up paying for this shopping spree for the next 25 years. “Follow this path only if you plan to repay the balance quickly,” he says.
Here are some additional advantages and disadvantages of exporting a HELOC:
Can only offer interest payments for the first year (a)
It can allow borrowers to access recycled value credit up to a certain percentage of their home value (usually 85%)
Interest can be tax deductible if the funds are used to improve the value of your home
It can be used as you wish
Interest-only payments require extra discipline and may encourage spending beyond your means.
Could charge closing costs, such as for a home mortgage (but not always)
You usually need at least 15% to 20% equity in your home to qualify
Failure to pay can lead to the foreclosure of your home
5 Common uses for a HELOC
You do not need to use a HELOC just for home-related expenses.
If you are wondering what else you can use a HELOC, here are some options:
HELOCs are “especially good for home improvement projects when you do not know what the final cost will be,” says Michelle Lambright Black, a credit expert and personal finance writer. Construction projects are notorious for over-budgeting or changing the scope in the middle of the road and you do not want to run out of money before your project is completed.
Many people use HELOC to consolidate high interest rate debt and reduce their monthly payments. This strategy can work as long as you have a final plan for repaying the debt.
According to Lambright Black, one “hidden benefit” of using a HELOC to pay off your credit card debt is that it can improve your credit score. Credit bureaus do not include the use of HELOC in their credit score, so moving your credit card debt to a HELOC could lower your reported credit score. Such a boost in your score could help you qualify for better interest rates and terms on other loans.
Purchase of another property
If you want to buy a holiday or rental property, a HELOC can simplify the process. Assuming your home equity is comparable to the cost of another, using HELOC as opposed to a traditional mortgage could help you avoid the standard 30 to 60 day sponsorship process.
Assuming you could afford to “cash out” your HELOC, your bid for a new home can be considered stronger by competing buyers, as it will not depend on bank financing.
An emergency reserve fund
The general rule of thumb is that you should have an emergency fund that covers the costs of three to six months. While this is ideal, the reality is that most families do not have as much on the sidelines for emergencies. A HELOC can serve as a contingency fund in case something unexpected happens.
Coverage of business expenses
Business owners can often use a HELOC with lower interest rates than those charged on a small business loan. In addition, a HELOC does not require your business to be open for two years before being approved, as most small business loans do. HELOC can be used to start a new business, cover ongoing costs or expand an existing business. But be aware of the risks associated with investing in a business that uses your home as collateral.
Alternatives to a Equity Credit Line (HELOC)
If you need funding but do not think a HELOC may be the best choice for you, here are some alternative ways to get the funding you need:
Redemption by redemption
With interest rates close to historical lows, cashback refinancing on your existing mortgage can lock in low interest rates for the next 15 to 30 years. According to Fleming, redemption refinancing “is a good idea if your current mortgage does not have a low interest rate”. And, since a traditional mortgage payment includes both principal and interest, your balance is reduced with each payment. By comparison, paying interest-only HELOCs during the lottery period would not reduce your initial balance.
Credit card 0% offer APRI
Many credit cards offer an interest-free promotion period upon first opening your account. These 0% APR offers can be used for purchases, balance transfers or sometimes for both. Some of these offers can last up to 18 months or more. While some banks charge a balance transfer fee of 3% to 5%, they usually do not charge a commission on purchase offers.
“These promotions are a good idea if you can repay the balance before the offer expires,” says Lambright Black.
Personal loan or credit line
While personal loans or personal credit limits may have higher interest rates, they can generally open up very quickly. In some cases, borrowers can see cash in the bank account on the same day as their application.
Most HELOCs, meanwhile, require evaluation and sponsorship may take a few weeks before the application is approved. Not to mention, HELOCs sometimes require you to keep your credit line open for at least a few years. Therefore, if you need fast cash for a specific purpose (and intend to repay it quickly), personal loans may be preferable in this scenario.