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 There are some things you would change, though, like that outdated kitchen or bathroom. Of course, you would love to remodel it, but that's expensive and just not in the budget this year. This is where some people take out a line of credit on the equity in their home.
Home equity means partial or full ownership of a home. Home equity value will increase as you pay down your mortgage or (if you're lucky), your property value independently increases.
It may seem like a great idea to take out a home equity line of credit, but you really need a complete understanding of how these loans work — the positives and negatives — to make it worth your while.
Read through to educate yourself before you go to a lender.
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With that being said, money can only be withdrawn for a set period of time. According to Bank of America, you are usually given up to ten years to take money out. 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, or consolidating debt with higher interest rates (such as credit card debt). You should not take out these loans to cover everyday necessities. If you cannot pay your bills with your current income, you should take time to come up with a manageable 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. NerdWallet notes that borrowers will usually be able to access 85% of their home equity. (Note that borrowers usually have to have a credit score higher than 600 to make the cut, too.)
As an example, if your house is worth $600k and you have paid down $400k, your bank would offer maybe 80% of the home's value. That would be around $480k. You would then subtract the $200k you owe making your max credit limit $280k.
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 or variable 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.
Both Nerdwallet and U.S. News rank HELOC lenders in 2018. Among the top results:
Criteria range from lack of additional fees like closing costs, preapproval rates, and flexibility on loan terms.
What's most important is that you feel comfortable asking questions of the loan provider and find people at the bank you can work with and trust. A loan isn't simply a paper contract. It's something that can be deeply personal and have an enormous effect on your wellbeing. You want to be sure you find partners you can go through this process with every step of the way.
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 you borrow money. All in all, you should be prepared 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. You can also use the pool of cash to re-finance other debt. 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. Ask as many questions of financial professionals as you can. If you have any concern about being able to make the payments, this type of loan may not be for you.