A Home Equity Line of Credit (HELOC) is a flexible line of against the value of your home – you use your home’s equity as collateral. Usually, the borrower agrees to a certain maximum amount they can borrow over a specified time period. In some ways it is similar to a credit card because the borrower has a credit limit, and can take out money as needed as long as they don’t exceed the amount of the HELOC.
Why get a HELOC?
A HELOC is a great way to have an available line of credit whenever you need a large amount of money. Many times the HELOC loan rates are better than credit cards because the debt is secured by your home equity (translation – if you don’t pay it back, your home could be on the line). Credit cards are unsecured loans and generally have much higher rates.
Many people use HELOCs to pay for home improvements, debt consolidation, or as a ready source of cash for an emergency fund. However, I don’t recommend using a HELOC as an emergency fund unless it is absolutely necessary. It’s best to have an actual cash emergency fund.
In many states, the interest payments for a HELOC are tax deductible (up to $100,000). This lowers the effective interest rate you pay on the loan. AMT rules or other laws may interfere with your ability to claim this deduction; do your research before borrowing with the assumption you can deduct interest payments.
Things to look out for with a HELOC
The interest rate on a home equity line of credit is usually variable and based on an index such as the prime rate plus a margin (the prime rate is the rate at which banks can borrow money). This means your interest rates can and likely will change. If your loan has a long amortization schedule, be prepared to have your payments change several times over the course of your loan.
The HELOC often comes with an annual fee, which is something you need to consider. Many times this fee is not disclosed, or is in the “small print.” Be sure to ask before signing any paperwork.
Your HELOC is secured by your home equity. That means if you do not pay your loan back, your home could end up in foreclosure. You should also be of your home’s value and how much equity you have. It is not wise to borrow more money against your house than your house is worth.
Get current rate quotes for HELOCs:
Do not borrow money with a HELOC just because a banker or lender says you can. Just because a lender sells you on the idea that you can tap your home’s value for a loan doesn’t mean you should. Only take out a HELOC because it is the best option for your situation.
Over the last few years real estate values increased dramatically and people used their home’s increased value as an excuse to upgrade their lifestyle by borrowing money they couldn’t afford to pay back. A vacation or a new car is not a good reason to borrow against your house.
Used correctly, a HELOC is a great financial tool. Used incorrectly, and you could be betting the house.