Is a HELOC the right fit for you?

February 28, 2022

By Jamie Smith

Is a HELOC the right fit for you?

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A HELOC is a revolving line of credit that lets you access a portion of your home's equity and uses your home as collateral. Learn more about the advantages and disadvantages of getting a HELOC.

Pros of HELOCs

HELOCs are advantageous to homeowners who qualify for them. Some of the key benefits of this borrowing strategy are:

Early access to equity

When you purchase a home, you often pay a 20% down payment and make monthly payments that cover portions of the principal and interest of your mortgage loan. The down payment and principal payments add to the equity in your home over time. You can calculate equity as the value of your home less the remaining balance of your mortgage.

Typically, equity stays locked in your home until you sell the property and are given money for the sale. However, that can be several years in the future. HELOCs allow you to access up to 90% of your equity as you need it.

Versatility

HELOC funds can be used for a lot of purposes. One of the most common uses of a HELOC is to cover the costs for a home improvement project; HELOCs often have lower interest rates than financing programs for home renovations. But HELOCs can also work for medical bills, college costs and even monthly expenses during a period of unemployment. HELOCs allow you to decide what the funds should be used for and let you access the funds any time you need them during the draw period.

This is a more flexible option than most loans, which must be used for specific purposes such as business or college expenses.

Convenience

Once you have a HELOC, you can access the funds easily. For example, the lender can send you requested fund amounts via check or a money transfer to your account. A simple transfer lowers the barrier to accessing your funds because these options are fast and easy, and they integrate well with modern purchase options.

Debt consolidation

With a little creativity, HELOCs are more than just flexible. Instead of covering future debts and expenses, you can use them to consolidate high interest rate debts from credit cards or other sources. HELOC owners can pay down those other debts with a HELOC and then begin making payments with lower interest rates during the draw and repayment periods.

Ability to make different decisions over time

Another advantage to using a HELOC is the ability to withdraw funds for different purposes. For example, a $200,000 home with $50,000 left on the mortgage could be approved for a HELOC of up to $135,000. However, you don't have to withdraw that entire amount immediately. In fact, you might never withdraw that full amount. Over the draw period, you could pull $20,000 for a home renovation one year and take semi-annual withdrawals of $10,000 for college tuition for four years. You only start incurring interest when you withdraw funds, and you know you have more if you need it.

Ability to improve your credit

It may seem counterintuitive that taking out a HELOC can improve your credit, as you're incurring more debt. However, consistent and on-time HELOC interest payments, as well as HELOC principal repayments, demonstrate that you're a low-risk borrower. This can boost your credit score over time.

Low interest rates

HELOCs offer relatively low interest rates, especially compared to unsecured loans and credit cards. That's what makes HELOCs a valuable tool for consolidating debt and using HELOC as a lower interest option.

While most HELOCs have adjustable interest rates that may make homeowners nervous, HELOCs are legally required to:

  • Have a lifetime cap on how high the interest rate can climb.
  • Have a quarterly cap on how high the interest rate can climb (applies to most HELOCs).

Fewer fees than comparable options

Not only do HELOCs have low interest rates, but they also have fewer fees than other equity-accessing options. For example, homeowners with good credit can have their closing costs waived. You may also be able to waive appraisal and application costs, depending on your lender. Cash-out refinances, on the other hand, require homeowners to cover closing costs.

Tax savings

HELOCs are classified as a type of mortgage. If you itemize your taxes, that means you can deduct interest payments made on drawn HELOC funds. Single filers can deduct up to $50,000 of interest payments from their taxes.*

The ability to pay on your own schedule (early payments)

Some loans lay out penalties and fees for early repayment, but that's not true with HELOCs. While principal repayments don't have to start until after the initial draw period, you can pay back borrowed funds earlier. This allows you to both use the loan as a revolving line of credit and minimize your interest fees over the course of the HELOC.

Cons of HELOCs

HELOCs have several advantages, but take a balanced look at the pros and cons of HELOCs. Some considerations to keep in mind include:

Variable interest rates

HELOCs have variable rates. Variable interest rates are adjustable — that is, they can change over time. These interest rates are based on the benchmark prime rate. However, there are protections in place to cap how much the rate can increase over time.

More payments added to your monthly budget

When you have a HELOC, you eventually need to start making repayments on the drawn funds. This will be an added expense each month once the repayment period begins, and that can be overwhelming if you aren't ready to manage the cost.

Defined withdraw period

HELOCs generally last 15 to 30 years. However, you can only withdraw funds during the draw period. The last years of the HELOC arrangement are the repayment period, when the borrower must make repayments and can no longer access funds. If you want to access more funds, you could refinance your HELOC.

Risk

Ultimately, a HELOC is using your home as collateral to back the loan. There are two risks to consider:

Inability to repay

If you reach the repayment period but can't afford the monthly payments, your lender may charge you additional fees, put a lien against your home, or even repossess your home. You may be able to refinance your house to forestall this process.

Lower home value over time

If you get a HELOC during a real estate bubble, your equity will be very high; your HELOC amount will also be high. But once the market calms down or your home loses value, you may have less equity in your home. This could mean you can't sell or refinance your home to cover HELOC repayment obligations.

Alliant Credit Union is here to help you find the right solution

A HELOC grants you early access to your equity and can help you manage your personal finances. Learn more about a HELOC today!


Looking for more information about HELOCs? Read these other blog posts:

 

*While the information provided is based on our understanding of current tax laws, and has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.


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