What is a home equity line of credit?
A home equity line of credit (HELOC) is a revolving line of credit based on your equity -- the part of your home that you actually own. As you make your monthly mortgage payments and put money toward the principal of the loan, you build up equity in your house. Equity also builds as your home appreciates. You can tap into this through a home equity line of credit.
How does a home equity line of credit work?
In many ways, a HELOC works much like a credit card. When you take out the loan, the lender sets a limit. Using lender-provided checks, you can borrow an amount up to that predetermined limit. Any amount that you borrow from the home equity line of credit is deducted from the amount available to you. As you pay it back, however, the amount becomes available to you again. Usually, a HELOC has a variable interest rate. You only pay interest on the amount that you withdraw, and the minimum monthly payment is usually interest-only or a small percentage of the outstanding balance. However, by stretching out payments, you make the total cost of the loan much more.
What is a good use of a home equity line of credit?
Home equity loans are generally better if you need the money all at once. A home equity line of credit is more appropriate if you need the money spread out over intervals. Here are some circumstances under which a home equity line of credit is preferable:
- Home improvements. If you plan home improvements but plan to do them in stages, a home equity line of credit may be a good choice, especially if the home improvements are a series of do-it-yourself projects that require multiple purchases from the home improvement store.
- Medical bills. If you have impending medical bills, a home equity line of credit can help you to pay them. Since the medical bills come as the treatment comes, a home equity line of credit makes it easy to pay as you go.
- College tuition. A home equity line of credit can also be used to pay for college tuition. With tuition bills due every semester, it is a convenient way to pay.
What are the advantages and disadvantages?
In circumstances where you need money over a period of time, a home equity line of credit can be advantageous. Instead of interest adding up for the entire sum of the loan, it only builds on the amount you actually use. This can be of great savings to you, and there is also great convenience with the checking account approach. Additionally, most home equity lines of credit do not have closing costs.
A home equity line of credit also has its disadvantages. You are using the equity in your home, which means that it will not be available to you upon the sale of your home. For example, if you owe $100,000 on your mortgage and you sell your home for $200,000, you would normally make $100,000 minus the real estate agent fees and selling costs. If you also have a $50,000 second mortgage, you will receive just $50,000 minus the other costs. Also, since your home equity line of credit has a variable interest rate, it could always go up. A HELOC may also have an annual fee.
After you have weighed your options and considered your needs, a home equity line of credit can be a useful tool.