Owning a home comes with its perks. It is not only an investment, but also you get to enjoy the equity. Equity is typically the difference between the mortgage loan and the home’s worth currently. If the mortgage loan isn’t very huge, less than 80 percent of the total value of the home, you can utilize the equity to manage the debt or even build more wealth.
One basic tool for borrowing finance against home equity is a home equity line of credit (HELOC). It allows borrowers to tap into their equity when the need arises. The great flexibility it offers makes it a wonderful option for borrowers. The catch is that HELOC comes with lower rates than credit card or instant personal loan because the home acts as collateral. Despite that, they come with risks, too. Keep reading to learn the risks and rewards of using home equity lines of credit.
Meaning of Home Equity Lines of Credit?
Also termed HELOC, home equity lines of credit provide the flexibility of accessing the revolving finance on a home’s equity. This source of funding tends to come with low rates when compared to other forms of home loans. Home equity lines of credit can thus be a wonderful option to fund any major costs you might have, like renovating a home, consolidating debts, or even handling the expenses resulting from an emergency. Though it is not an emergency loan, it can be used as a substitute to handle the emergency.
HELOC functions are almost similar to credit cards. You are allowed to withdraw and use the funds on any need that arises, as you make interest payments only. When the repayment tenure nears, you have to start making the monthly payments to the lender. This involves principal amounts and interests.
Your home is usually used as collateral before you can secure the loan. It, therefore, means you may lose it if you are unable to pay in full. Whether a home equity line of credit makes sense depends on your financial situation.
Rewards of Using a HELOC
Whether it is home renovation, medical costs, or college expenses, a HELOC can come to your aid.
These are the rewards you can enjoy from using HELOC;
1. Low rates
The first reward you may see with home equity lines of credit is the low interest rates it comes with. Typically, the HELOCs are just mortgage loans where the home is used as collateral. Therefore, they are secured and as you know, secured loans usually come with lower rates as compared to unsecured payday loans or credit cards.
Even though this sounds like a huge commitment, it is beneficial. With a HELOC, you may get a more attractive rate. The lower interest rates imply that you will pay less. Normally, the interest rates for home equity loans are fixed. But, for HELOC, it starts with a lower introductory rate which then becomes variable with time. But, some caps will help limit the rates from increases in case they do. Despite this uncertainty, the rates for HELOC are usually lower than many types of loans.
2. Flexible to use funds
The best part about HELOC is that you can use your funds as you desire. Besides, you only have to repay the interest on the borrowed loan. If you get less cash, the payments will also be smaller.
Home equity lines of credit do not come with restrictions. Most people use the funds for renovation projects, while others set the funds aside for expenses that are completely unrelated to the house like consolidating debts on the credit card. This is also a good way to use the funds, but make sure you’re not using it on unnecessary things.
The flexibility offered by HELOC can be related to that of credit cards. You only make payments on what you used and repay it, then reuse it again.
3. The closing costs are low
Closing costs are used to cover services offered during the period of the loan approval procedure. These costs can be credit checks, appraisals, or inspections. Mostly, the mortgage loans have closing costs that range between 2 to 6 percent of the purchase price. Home equity loans can also fall within that range. But, when it comes to HELOC, things are far much better. The closing costs may be significantly lower than or even there may not be any costs at all, especially for those with excellent credit histories.
4. Potential tax benefits
In some cases, a home equity line of credit may allow tax benefits if the funds are used to renovate the same house. If you use the money to improve the home, it will increase its value. Using the funds to remodel a home may allow you to deduct the interest. But, it is advisable to consult a tax advisor.
5. It can boost your credit
The major components of the credit score are credit mix and payment history. With a HELOC on your credit history and at the same time paying the interest on time will help boost the score. On the other hand, raising the credit utilization ratio will most likely reduce the score. So, balance these two and see your credit score skyrocket.
Risks Associated with HELOC
HELOCs also come with some risks, and you need to familiarize yourself with them. These are the risks associated with them;
1. The rates may vary
The interest rates on home equity lines of credit are variable, meaning that the rate may change based on where the current rates of HELOC are. Normally, the interest rates are charged based on the prime lending rate. When they rise, the HELOC rates also rise, and vice versa. This makes it challenging to budget for the payments.
2. Your property is at risk
A home equity line of credit is a type of secured loan where your house stands in as collateral. This form of financing is very different from the unsecured NBFC loan. The collateral is at risk as it’s on the line whenever payment isn’t made. Though the security assures you to get a lower rate, anytime it can be liquidated by the lender. Make sure you’re prepared for payments and carefully manage the credit responsibly.
3. There could be prepayment penalties
You will find some lenders charging fees when you close the HELOC quickly. Often, a lender can charge you for the closing costs. Home equity lines of credit are thus more suitable for homeowners looking to remain in that property for many years because some lenders may change the repayment costs when you close the loan early.
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