With the average interest rates on credit cards reaching 15 percent, consumers can be weary of using them to finance their purchases. Instead of using credit cards and paying high interest rates, some consumers are turning to home equity lines of credit (HELOCs) to make improvements to their homes, pay for weddings or college educations, and use in case of an emergency.
What is a HELOC?
A home equity line of credit, or HELOC, is a revolving line of credit that uses your home as collateral. By using your home as collateral, you can borrow funds at a much lower rate of interest than that charged by credit card companies. It acts just like a credit card would, except your home is collateral which in turn gives you a lower interest rate.
The amount you can borrow depends on the amount of equity you have in your home. Most lenders will insist you have between a 75 and 80 percent loan-to-value ratio after receiving the HELOC. However, some borrowers will enable you to borrow up to 125 percent of the value of your home less any existing mortgages. You simply multiply your home's value by 125 percent and subtract the amount you still owe on your mortgage. But just because a lender will lend you more money doesn't mean you should accept it. It's always best to borrow the minimum amount of funds you might need.
Benefits of a HELOC Versus a Credit Card
- Lower interest rates. HELOC interest rates are based off of the prime rate plus a fixed rate depending on your credit score. The higher your credit score, the better interest rate you will qualify for.
- Paying less in interest charges means you can pay off your debt faster. You'll have more money each month to pay down the principal. If you can afford to make only the minimum payments on your credit card bills, most of what you are paying is interest.
- The interest on a HELOC can usually be deducted from your taxes. Provided the total debt isn't more than the fair market value of your home, up to $100,000 usually qualifies as a tax deduction. Consult a tax advisor to find out how this may apply to you.
- A HELOC can be used to consolidate your debt. When you have multiple credit card bills to pay, it can be easy to fall behind. A HELOC allows you to consolidate your credit card debt, if you choose, and only have one monthly debt payment to make each month.
- When shopping for a HELOC, read the credit agreements carefully. The annual percentage rates quoted won't include any set-up fees, so be sure to compare these costs among lenders.
Provided you use a HELOC cautiously, it can be a great tool to pay for unexpected expenses or make improvements to your home instead of relying on a credit card. Just be sure to repay it as soon as possible and don't be tempted to spend more than you need simply because you've been granted a generous credit limit.