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What is a HELOC and how does it work?

Couple uses a HELOC to pay for renovations
December 28, 2018

By Kathryn Pins

When you have big expenses, it’s good to know your financial options. Many people don’t know that a HELOC is a way to get the cash you need when you need it. So, what is a HELOC and how could it help you?

What is a HELOC?

HELOC stands for Home Equity Line of Credit. It is an “on-demand” loan that leverages the equity in your home. Your home equity is the difference between your home’s market value and the remaining balance on your mortgage. If you put a good amount down on your home and you’ve been making payments for a few years, you probably have a lot of equity in your home to borrow against.

A HELOC allows you to borrow from your home as a line of credit, similar to a credit card. You can borrow what you need, when you need it, up until you reach your credit limit. So, like a credit card, you have a line of credit that’s there as you need it. If you don’t use it, it’s still there, just in case.

HELOCs have a draw period and a repayment period. The draw period is when you’re able to take money from your line of credit. The repayment period is when you make payments back to your principal (which you can do during your draw period too). For example, you could have a seven-year draw and a 15-year term. You can take out money for seven years, but you have a long time (15 years) to make payments back. So, you can take your time if you need to pay for that big expense.

When could you use a HELOC?

A HELOC is helpful when large expenses come your way, whether they’re planned or unexpected. It’s common to use a HELOC to pay for home repairs and remodels. However, most people don’t realize that a HELOC can also be used for debt consolidation, medical bills, or many other big ticket items. With a HELOC, you could get a lowinterest rate and flexible low monthly payments, which is why it’s ideal for big expenses.

Instead of cashing in valuable investments, a HELOC could be a good alternative. It’s important to take a look at the possible interest rate on your HELOC and compare it to your investment returns to make the right decision for you.

 

What is a HELOC Interest-Only?

A HELOC Interest-Only (also known as an IO) is a line of credit as explained above, but you only pay interest (and principal, if you choose) for a part of your loan. After that point, you will pay full principal and interest payments. For example, with an Alliant HELOC IO, you could pay interest only for the first 10 years, if you choose. After 10 years, you will pay principal and interest like a traditional HELOC. A HELOC IO is good if you anticipate needing funds and want lower interest-only payments now.

How to shop for a HELOC

Not every HELOC is the same, and you don’t have to get a HELOC from the same bank where you have your mortgage. Compare interest rates so you know you are getting the best deal. When shopping around, look for a HELOC with no closing costs or appraisal fees. Those extra fees can add up very quickly. Also, check your credit score before applying. If it needs a boost, here’s how to score an even higher credit score.

A HELOC is valuable when your expense is bigger than your emergency fund. It is just one of the ways to pay for a large expense.


Kathryn Pins is a marketing content specialist at Alliant. She’s passionate about finding and communicating meaningful financial information with Money Mentor readers. Kathryn is a saver who gets more excited about certificates and her Roth IRA than shopping. When she does spend her earnings, it’s on furthering her education, travel, unique experiences, and loved ones.