Should I get a HELOC or a HELOC IO?

February 28, 2022

By Jamie Smith

Should I get a HELOC or a HELOC IO?

A family enjoys their new kitchen after deciding to get a heloc vs. heloc io

A home equity line of credit (HELOC) is a revolving line of credit that works a lot like a credit card. It has lower interest rates than a credit card, and you can get a much higher credit limit because the equity in your home secures the HELOC. With an interest-only home equity line of credit (HELOC IO), you can make lower, interest-only payments for the first part of the HELOC IO's term. HELOCs and HELOC IOs can both have pros and cons. Here's some more information to help you decide which one is best for your needs.

How HELOCs and HELOC IOs work

A home equity line of credit is an excellent way to get the funds you need for fun vacations, emergency expenses or renovations. The credit limit of a HELOC or HELOC IO depends on the equity in your home. Equity is the difference between the amount you owe on your mortgage and your house's current market value. If you've already paid off your mortgage or you bought your home with cash, your home's market value is the same as its equity.

Each HELOC and HELOC IO has a credit limit, a draw period, and a repayment period. During the draw period, you can withdraw as much money as you need up to your credit limit. You'll only need to make minimum payments, and you can borrow more if you're not too close to your credit limit. The repayment period is the rest of the HELOC's or HELOC IO's term after the draw period ends.

The pros and cons of HELOCs

The interest rates with a home equity line of credit are much lower than the rates you could get with a personal loan or a credit card. You could borrow from your 401(k) or another retirement account, but most people have to repay the money within five years or risk additional taxes and penalties from the IRS. These costs can sometimes be higher than the amount you would pay in interest for a HELOC.

With a HELOC, you could have up to 30 years to repay what you borrow. For example, a HELOC with a 30-year term could have a 10-year draw period and a 20-year repayment period. You would make lower payments and be able to withdraw more at any time during the first 10 years. After that, your payments would increase so that you could pay the balance before the term of the HELOC ended.

Since you don't have to take the money in a lump sum like a traditional home equity loan, you can save money on interest by borrowing only what you need and repaying the balance as soon as possible. Even if your credit score isn't great, you can qualify for a HELOC or HELOC IO as long as you have enough equity in your home.

The benefits and risks of HELOC IOs

You only need to pay interest during the draw period of an interest-only home equity loan. The lower payments make them more affordable during the first ten years of the line of credit, especially if you're still making payments on your mortgage. However, you'll probably need to make larger payments during the repayment period because you were only making interest payments the first few years of the HELOC IO.

HELOC IOs are ideal for renovations. The draw period can last for a decade, meaning you can get the cash you need when you need it for ten years. You'll only have to pay interest on the money you use during the first ten years, and, if you choose, you can make additional payments to reduce the principal before the repayment period begins.

Be aware that payments with a HELOC IO could be larger than with a HELOC after the draw period. If you choose an interest-only home equity loan, plan for larger payments later in the life of the HELOC. Many people plan on getting a promotion or a higher-paying job before the repayment period begins, but it's a good idea to have a backup plan.

Which one is best for you?

A HELOC IO is the best choice for people who might not be able to pay the interest and principal for a HELOC right away. For example, someone planning to buy and rent a house may have to make some repairs before they can advertise for tenants. Then, they might need some time to choose a tenant and have them move in. With a HELOC IO, they can make small payments until the house is in good shape and they start receiving rent from a reliable tenant.

For many people in similar situations, a HELOC IO is the best option because of its flexibility. You can make additional payments even during the draw period, and you can pay only interest whenever you have unexpected expenses. However, you need the willpower to make additional payments when they're not required, or the ability to make higher payments during the repayment period. With a HELOC or a HELOC IO with Alliant Credit Union, you won't have to pay closing costs or appraisal fees for lines of credit up to $250,000.

A regular HELOC distributes your payments more evenly. A HELOC is also the better choice if you're refinancing other debt and you want to save on interest rates.

With a home equity line of credit (HELOC) or an interest-only home equity line of credit (HELOC IO), you can achieve your dreams. These lines of credit are ideal for taking care of unexpected expenses, making investments in your home or buying yourself an expensive treat like a new car.

Unlock the value of your home

An Alliant HELOC could help you get the funds you need when you need it. Pay for a home renovation, vacation home and more.

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