A home equity line of credit, also known as a HELOC, is a second mortgage that enables you to withdraw cash from your home’s value. This can be used for any purpose, such as for emergencies or large purchases. If you have no emergency funds available and you need the money in an emergency situation, the HELOC might be your best option.
However, there are many misconceptions about how a HELOC works and whether it is right for you. This article will help you sort through the myths and figure out if a home equity line of credit is a good option for you and your family.
What is a HELOC?
A HELOC is similar to a credit card, but it’s loaned money against your home’s value. Just like with other types of loans, you have to pay back the money you borrowed (plus interest) within the specified time frame. You can use the proceeds from your HELOC to pay off other debts, and you can even get a lump sum in cash out of it.
Since a HELOC is a loan against your home’s equity, it’s most often used by homeowners who are facing the prospect of losing their homes or having to pay an excessive amount of money on their mortgage payments. The HELOC allows them to reduce the amount of money they owe on their mortgage.
Advantages of Home Equity Line of Credit
HELOCs have several advantages over other types of loans:
- You only pay interest on what you borrow, instead of paying interest each month on the total amount you owe.
- You can get a lump sum in cash immediately.
- There is no need to worry about monthly payments.
- You can choose to make interest-only payments or to make payments that reduce the balance owed over time.
Disadvantages of Home Equity Line of Credit
While HELOCs have a lot of advantages, there are also some disadvantages that you should consider before signing up for one.
- If you have an adjustable-rate mortgage (ARM), the interest rate on your HELOC may be higher than the current rate on your ARM, so you could end up paying a lot more money in interest.
- Depending on the state you live in, you may have to pay income taxes on the money that you borrow, which will increase your monthly payment.
- You could also lose your home if you don’t meet certain repayment requirements.
Requirements & Considerations to Qualify for HELOC
In order to qualify for a HELOC, you will need to meet several requirements, including the following:
- You must have sufficient equity in your home.
- Make sure you are a homeowner.
- You must demonstrate that you have enough income.
- It is not acceptable to have been bankrupt within the past one to five years.
- You must have a good credit history and score.
How a HELOC works?
Using a HELOC can be very beneficial for homeowners who have good credit and financial standing. People who are behind on mortgage payments or owe more than their homes are worth often use a HELOC to make up the difference.
Here’s how it works: Let’s say you want to buy a used car for $10,000, but your car is only worth $5,000 right now. You’ve got several alternatives: If you have the cash on hand that you can pay with, this is an option. You could take out a loan, but this would definitely increase your monthly payments and might even require some money down (as with the HELOC). If you really can’t afford the car, you could sell your old one and use the funds to buy a new one.
But consider this scenario: You’re facing an emergency that requires a cash purchase for over $5,000. You might not be able to get a loan in time to cover the added expense. The other alternatives would cost you hundreds if not thousands of dollars more than the car is worth. But you can use your HELOC to make up the difference and have a few hundred dollars to spare.
A HELOC can also be a great option for young people who are starting out in the world and have no emergency savings or credit history and could benefit from some extra cash. You may even find that it’s a good way to fund education with money from your home equity line of credit.