A home equity line of credit (HELOC) can be a convenient source of cash for big projects such as a home remodel or big bills such as a hospital stay. But because a HELOC is collateralized by your home, you should carefully weigh the pros and cons before using one. How do HELOCs work, and what are the best (and worst) reasons to apply for this type of credit? Read on. Show What Is a HELOC?A HELOC is a revolving credit line that lets you borrow against your home equity, using your home as collateral. (Your equity is your home's assessed value minus your mortgage balance.) You can typically borrow 60% to 85% of your home's equity. Most HELOCs have variable interest rates, usually with a rate cap. You can draw as much as you need from the HELOC up to the borrowing limit during the draw period (usually 10 years) and make interest-only payments on the amount you borrow. Unlike other types of revolving credit such as credit cards, HELOCs aren't counted as part of your credit utilization ratio by the FICO credit scoring model, so your HELOC balance won't negatively affect your FICO® Score☉ . After the draw period, you'll have to repay the loan in full, generally over 20 years. (You can also choose to refinance it.) HELOC payments rise substantially at this point, so be sure to budget for the cost. Some HELOCs let you pay down principal during the draw period, making post-draw-period payments more manageable. Like HELOCs, home equity loans use your home as collateral. Unlike HELOCs, however,
they are installment loans: You receive a lump sum and begin making fixed monthly payments immediately. Most home equity loans have a fixed interest rate. What's a Good Way to Use a HELOC?HELOC payments can soar when the draw period ends, and you could lose your home if you can't repay the loan. Because of this risk, HELOCs are best used for the following:
What Are Bad Ways to Use a HELOC?Aside from putting your home at risk, HELOCs also eat up precious home equity. During the Great Recession, many borrowers whose home values declined found they owed more than their homes were worth. To protect your equity, avoid using HELOCs for:
Alternatives to HELOCsIf a HELOC isn't for you, consider these other ways to finance big purchases or unexpected expenses.
Keep
in mind that borrowing money isn't the only way to pay off debt. Investigate all your options. For instance, if you have medical debt, you can ask about payment plans, negotiate with the medical provider or seek financial assistance. Overwhelmed with
credit card debt? A reputable credit counselor can create a debt management plan for you and work with your creditors to lower interest
rates, waive fees and reduce your payments. Is a HELOC Right for You?While HELOCs do offer lower interest rates and greater flexibility than many other financing options, the tradeoff is putting your home up as collateral. Before choosing a HELOC, carefully consider how it will affect your home equity, how you will pay it back, and whether less risky financing alternatives are a better fit for your needs. To qualify for a HELOC, you'll need a
good credit score plus significant home equity. Before applying for a HELOC or any loan, check your FICO® Score and credit report. If your credit score needs work, you can
help improve it by paying down debt, maintaining low credit utilization and not applying for new credit until you're ready to apply for the HELOC. Once you have a HELOC, make payments on time to help boost your credit score. What is the downside to a HELOC?One disadvantage of HELOCs often stems from a borrower's lack of discipline. Because HELOCs allow you to make interest-only payments during the draw period, it is easy to access cash impulsively without considering the potential financial ramifications.
When should you use HELOC?9 of the Best Reasons to Use a HELOC. Home improvements. ... . Pay down debt. ... . Pay tuition or other education costs. ... . Down payment on an investment property or a second home. ... . Pay medical bills or long-term care expenses. ... . Added cushion for an emergency. ... . New business venture. ... . Paying off student loans.. |