When the housing market crashed in 2008, it took a lot of equity with it. Many homeowners suddenly found themselves underwater on their mortgage and unable to refinance or sell their homes at anything near the price they’d paid for them. These days, however, it is safer than ever to take out a home equity loan or line of credit as long as you use one responsibly.
A HELOC allows you to access money from the value of your home without having to sell your house or take an equity mortgage and pay interest as you would with a home equity loan. A HELOC also allows you to borrow up to a pre-specified amount at any time, giving you liquidity and flexibility.
How a Home Equity Line of Credit Works
A home equity line of credit, or HELOC, is a type of revolving credit that lets you access a specific amount of money from your home’s value on a revolving basis. The line of credit amount is determined by the value of your home (not your mortgage amount) and the amount you can borrow varies from lender to lender.
HELOCs are typically unsecured loans, meaning you don’t need collateral or asset equity to get a HELOC or to keep it if you are currently underwater on your mortgage. That’s because, unlike other types of home equity loans, a HELOC is not a lump sum payment loan, but rather a line of credit that you can use over time. This type of home equity loan has a long repayment period, usually between 10 to 20 years, and you will generally pay interest only on the amount you use.
Pros of a HELOC
A HELOC can be good for you if you need a large amount of cash, especially early in the life of the loan when the payments will be lower. You may also get a better interest rate on the HELOC than you would for a mortgage refinance. If you can find a lender who will let you take out a HELOC on top of your current mortgage, you may be able to avoid an equity mortgage altogether.
Since HELOCs are unsecured loans, you can get a HELOC even if you have bad credit or have a lower income. A HELOC comes with low or no closing costs, and the interest rate is often fixed, making it predictable. Unlike a home equity loan, you don’t have to pay back a HELOC in one lump sum. You can pay off the interest and principle as you go.
The flexibility is also an advantage. You decide how much and when to draw from your line of credit, and you can repay it monthly or pay the minimum amount due. If you have a tight budget, this can help.
There are also no prepayment penalties. If your financial situation improves and you can afford to pay more than the minimum monthly payment, you are not penalized. Again, they also have a lower interest rate and only pay interest only on the amount of money borrowed.
Cons of a HELOC
A high-interest rate is the biggest drawback of a HELOC. Even if you get a fixed rate on the loan, it may end up costing more in interest because it is unsecured. If you are unable to make payments on your home equity line of credit, the lender can foreclose on your home and sell it to pay off the debt.
If you’re underwater on your home, you might not get the full amount of equity you need. A HELOC is an unsecured debt, which means if you don’t repay it, there is no collateral to seize. This can mean a much lower credit score and higher interest rates if you ever apply for another loan in the future.
When deciding whether or not to apply for a HELOC, you should consider a few things such as, how much equity you have in your home. If you’re underwater on your mortgage, you may not be able to get a HELOC against your home’s equity.
Your credit score will be taken into account when lenders decide whether or not to approve your application. The higher your credit score, the better your interest rate will be. Before applying for a HELOC loan, you should always try to improve your credit score if possible, You can do this by lowering the balance on credit cards and paying off any debts.
Your financial situation. Will the loan be manageable in your current financial situation? A HELOC is a long-term loan, and you will have to make payments for the length of the loan. If you’re in debt on your mortgage, you may be able to get a HELOC on top of your current mortgage. This will make your payments easier to manage and help you avoid a cash-out refinance.
Final Words: Is a HELOC Right for You?
If you need cash, have good credit, and you don’t have a ton of equity in your home a HELOC is a good option for you. It’s a safe and simple way to get access to cash at a manageable rate. You can only borrow 100% of your home's equity, so a cash-out refinance may be a better option if you need more than that. A HELOC is a good option if you have a plan, are disciplined, and know you can repay the loan. If you need cash to make a large, one-time purchase like a car or a house, a HELOC is a feasible option.
Like all loans, they come with risks, but they can also be a good way to access extra money. If you can repay the money over a few years, it can be a good way to get cash without taking on new debt. Before you apply for a HELOC, make sure you understand the terms, costs, and risks associated with this type of loan.
