What Is a HELOC? Should I Borrow Against My Home?

Lucy Lazarony
November 10, 2020

A home equity line of credit, also known as a HELOC, is a line of credit secured by your home. With a HELOC, you get a revolving credit line to use for large expenses, such as home improvements. You also can use a HELOC to consolidate higher interest rate debt, including credit cards. A HELOC has a lower interest rate than many other kinds of loans making it a good debt consolidation tool. Just be sure to work on paying down the debt at the new lower interest rate until your debt total falls to zero. Wondering how a HELOC works? First off, to qualify for a HELOC you need to have available equity in your home. This means the amount you owe on your home is less than the value of your home. With a HELOC, you can typically borrow up to 85 percent of the value of your home minus the amount you owe. When you apply for a HELOC, a lender also looks at your credit score and credit history, your employment history, your monthly income and your monthly debts. Be prepared for variable rates because many HELOCS come with variable interest rates. When you have a variable interest rate on a home equity line of credit, the interest rate could change from month to month. This means your payment amount may change from month to month as well.

Fixed-Rate Options

Some lenders allow you to convert a portion of an outstanding HELOC balance with a variable rate into a fixed rate. With a fixed-rate loan, you don’t have to worry about your interest rate changing from month to month. Having a fixed-rate loan is a steady way to tackle debt.

Understanding How a HELOC Works

When you have a HELOC, you are borrowing against the available equity in your home and your home is used as collateral for the line of credit. As you repay the line of credit, the amount of available credit increases. And you are able to borrow again against the line of credit if need be. You are able to borrow money from a HELOC during a draw period of typically 10 years. At the end of the draw period, the repayment period begins and this is typically a 20-year period. So with a HELOC, there is plenty of time to pay back the money that you borrow.

And because a HELOC is a line of credit, you only make payments on the amount you borrow.

Ease of Use

A home equity line of credit gives you a revolving line credit that is similar to a credit card. You can borrow as much as you need as long as you don’t surpass the line of credit. You can pay for items with a home equity line of credit by writing a check or using a credit card connected to your HELOC account.

Understanding Monthly Bills

As you withdraw money from a HELOC, you’ll receive monthly bills with minimum payments that include interest and principal. Your payments may change based on your balance and the size of payments that you make. With a variable-rate HELOC, your payments also will change because of interest rate changes. Making additional payments to a HELOC will help you save on the interest charged and help you to pay down debt more quickly.

Watch Out for Fees

A HELOC may come with upfront fees such as an application fee. Other fees include an annual fee, a cancellation fee and an early closure fee. There are also fees that you pay through the life of the line of credit. There may be a participation fee, which is paid whether or not you use the account. And there may be a transaction fee, which is charged each time you borrow money in your HELOC.

Study these fees carefully. How much are you paying in fees for a HELOC? Would a different lender charge you a different amount? It is worth checking out.

Withdrawal Amounts

Ask your lender if there is a minimum withdrawal amount when you open a HELOC account. Also ask about minimum and maximum withdrawal amounts after you open the HELOC account. It is good to know just how much money is available to borrow in a HELOC account and if you are using the account sparingly you will want to keep your eye on the minimum withdrawal amounts. The maximum withdrawal amount to borrow is not something you’ll want to get close to with your borrowing on a HELOC. So if you are close to the maximum amount you’ll want to rein in your spending and move on to getting a pay back plan in place.

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Your Home as Collateral

It is worth mentioning again that a HELOC uses your home for collateral for your line of credit. If you are unable to make payments you put your home at risk. So only borrow for what is absolutely needed and have a plan for paying back the money that you borrow.

HELOC For Debt Consolidation

A HELOC has a lower interest rate than many kinds of loans. So it may be tempting to consolidate your other higher-interest rate debt, including credit cards into your home equity line of credit. Don’t forget your home is the collateral for a HELOC. So you’ll want to be careful about the amount of debt you take on. How much debt can you pay down during the loan’s 10-draw period? That 20-year repayment period looks mighty nice but that is a lot of interest to pay over such a long period. The best strategy is to have a plan for paying down debt. Can you pay it all back in five years? That is a good goal to have. You’ll enjoy a HELOC’s lower interest and you will pay off the debt in a few short years.

Check Repayment Options

Find out if you are paying back both principal and interest with your HELOC payments or are they interest-only? Interest-only payments are tempting because they are so small but you’ll want to pay more than the amount owed each month to really make headway on your debt.

Shop Around for the Best Deal

Interest rates and fees vary from HELOC to HELOC. You will want to shop around for the best deal. Start with your bank or credit union. They know you the best and already have a relationship with you. You may want to check with your mortgage lender. They approved you for a mortgage and they will likely approve you for a HELOC. But don't be afraid of new lenders and banks to see what they offer in terms of HELOCs. Remember you are looking for the HELOC with the best interest rates and fees. HELOCs, with 10-year draw periods and 20-year repayment periods, go on for a while so you will want to choose a lender that you like and trust. So take your time comparison shopping until you find the lender that is right for you.

Homeowners Insurance

You’ll want to maintain the insurance on your home regardless of whether or not you opt for a HELOC. For the best prices, let SmartFinancial compare home insurance rates for you. Just enter your zip code below.

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