A home equity line of credit (HELOC) uses the equity you have in your home to produce a certain amount of funds available at your disposal. Unlike a home equity loan, these funds can be taken out slowly over time, like with a credit card.
Typically, these funds are designated for repairs and renovations on your home. In the end, this results in greater equity in your house by increasing its value. Occasionally, these credit lines can be used for other things, like furthering your education.
If you’re considering this financial step, here are some tips to help you navigate the process of taking out a home equity line of credit:
Consider the Pros and Cons
There are many ways to obtain loans and lines of credit, so it’s important to evaluate the pros and cons of a HELOC before moving forward with the process. These questions will help you determine whether or not this is the right financial decision for you:
Are You Willing to Weather the Market?
According to Nerd Wallet, most home equity lines of credit don’t offer fixed interest rates. A few creditors will allow them down the line, but it’s very rare for it to be offered upfront.
If you’re someone who monitors the market and is willing to deal with the ups and downs of interest rates, then it’s time to move forward in the process. However, if the thought of a flexible rate terrifies you, a home equity loan may be better suited toward your needs.
When Do You Need the Money?
Lines of credit allow you to draw money from an account over time, just like a credit card. This is great for people who need to pay contractors as a job is completed. However, this won’t work for you if you need a large sum at one time. In that case, a home equity loan is more reasonable.
One extra benefit to lines of credit is that you only have to pay interest on the money you spend. Plus, most lenders will allow you to make interest-only payments for a period of time.
What Are You Using the Money For?
CNBC points out that tax laws have changed. Interest on HELOCs is now only deductible if you can prove it was used for home repairs and renovations. So, you won’t receive a tax benefit from using it for any other purpose.
Deductions are also capped out at $750,000. This includes your existing mortgage, as well.
Are You Willing to Risk Your Home?
If your financial situation changes and you’re no longer able to make payments on your HELOC, the lender can foreclose on your house. If you’re confident in your finances, it’s a great way to invest in your home. However, it isn’t the safest option for someone who is in financial trouble.
Shop Around
When it comes to any kind of credit, you always want to shop around. Never take the first offer you’re given. Most likely, it won’t be the best one.
Interest Rate
The Huffington Post says the main thing you should pay attention to is the interest rate. This is sometimes referred to as the start rate, but it’s the same thing as APR. This interest rate only lasts up to six months, so it’s important to ask the lender how long your rate is locked in for.
You’ll want to choose the lowest start rate, but know that this is no guarantee that your rate will stay low.
Margin
The margin is the percentage of interest that is added to the base rate to create your mortgage. A lot of lenders won’t want to disclose this, but you should always ask. Otherwise, you’ll be surprised when base interest rates stay the same but your loan rate increases.
Truth in Lending Statment
Before signing off with a lender, make sure you read their Truth in Lending Statement (TIL). This is required by law for all lenders. While it typically won’t disclose your margin, it will be required to list any hidden fees.
Occasionally, companies will entice you to sign with offers of reduced costs only to tack on a hidden fee at the end of your first year. If a potential lender is planning on doing this, you should be able to see it in their TIL.
Don't Miss Hidden Costs
The final paperwork isn’t the only place you’ll find hidden costs for a HELOC. Lenders sometimes state this information in an obvious manner so that an untrained ear doesn’t register it.
Inactivity Fees
A large number of credit cards charge inactivity fees if you go long periods of time without spending any money. The same method is used by certain HELOC lenders. It’s best to set a clear timeline for when funds will be used so that you can take out a line of credit for only the time you’ll need it.
Early Payoff
Because lenders make their profit from interest, most of them will institute a fee for paying off your loan early. This can be a set charge or it can decrease over time the closer you get to the end of your contract.
It’s natural to want to leave room in your loan period for delays in construction and other setbacks, but you don’t want to leave too much time. This could keep you indebted to a loan you don’t need, unable to close it early due to hidden fees.
Overall, home equity lines of credit are a great choice for those who are secure in their finances. You must also be willing to navigate the loan market, as interest rates aren’t set.
All the intricacies of this financial decision may sound complex, but as long as you do your research, you’ll find that a HELOC can give you the boost you need. Once you’ve secured approval, you’ll be able to make those repairs you’ve been putting off or start transforming your house into your dream home.
