You have just purchased a home that you love or you have been in your home for a while. There are some things you would change, though, like that outdated master bathroom. Of course you would love to remodel it, but that costs a pretty penny and it's just not in the budget. This is where some people take out a line of credit on the equity in their home (assuming you have some built in value to your home). This may seem like a great idea, but you really need to have a complete understanding of how these loans work as well as what the positives and negatives are.
With this type of loan, your home is used as collateral against the money you are borrowing from the bank. One of the key differences between this and other home loans is that you are not borrowing a set amount to pay back over a specified period of time. Rather, you borrow against a line of credit and make a partial or full payment towards the balance each month.
With that being said, money can only be withdrawn for a set period of time. You are usually given 5-10 years to take money out and any payments you make go solely towards the interest.
Using a home equity line of credit to do renovations and repairs to your home can be a smart move since this will usually add to the value of your home. Nonetheless, many homeowners take out one of these loans to cover other things. This includes paying for college, buying a car, consolidating debt etc. One reason not to take out one of these loans is to cover everyday necessities. If you cannot pay your bills with your current income, you should take time to come up with a maintainable budget.
Equity depends on the following: the value of your home and the amount still owed. This will be what your loan is based on. 75%-85% of the difference between the two is usually where your credit limit will fall.
So as an example, if your house is worth $500k and you still have $350k, your bank would offer maybe 75% of the home's value. That would be around $375k . You would then subtract the $350k you owe making your max credit limit $25k. Before a bank will consider giving you a loan of this size, they will look at not only your income, but your credit score and any other debts you have.
There are some things to keep in mind with home equity lines of credit. Some loans may require that you borrow a minimum amount every time or require that you take an advance at the inception of the loan. A few may even require that you always carry a balance. For this reason, it is important to know the details of any loan you take out.
Typically, home equity lines of credit carry an adjustable rate. This means the rate will fluctuate with whatever index it is tied to, like the prime rate. Luckily, the interest rate does have a cap for how high it can go. For example, if your loan has a 15% cap, you will not see it rise above that. Some plans may even offer an interest rate cap during a given time period.
Just like your mortgage, you will typically have to pay additional fees when you take out a HELOC. Here are some of the fees you may incur:
In addition, there are some loans that carry continuous fees that are applicable until the loan expires. This could be a loan management fee or transaction fee each time your borrow money. All in all, you can expect to pay hundreds in extra fees should you decide to open a home equity line of credit.
There are definitely some advantages to this type of loan vs others. Here are a few:
Although a HELOC can be a great way to borrow money, it’s not for everyone. HELOCs have some serious negatives, including:
If you make the decision that a HELOC is the right choice for you, be sure to comparison shop for the best deal. Contact your bank first as they may offer discounts for regular customers. Make sure to ask for a detailed quote that includes all information regarding fees, caps and interest rates. You can now use that as a base to compare other offers to.
Keep these details in mind as you shop around for a loan:
Taking out a home equity line of credit can be a smart financial move for many. It is a relatively cheap way to borrow money for improvements that can add value to your home. The main downside is that you are putting your home at risk should you not be able to make the payments. For this reason, it's important you review all your options and do the math. If you have any concern about being able to make the payments, this type of loan may not be for you.