Once a hot commodity in the 2000s—when real estate values soared—HELOCs (home equity lines of credit, also known as second mortgages) have gained popularity as home values again reach new heights.
Owning a home is a great way to plant roots and build wealth, and is typically a person’s most valuable asset, so if you have substantial equity in your home, you might consider leveraging that equity as a credit line for major events and purchases, such as education, home improvements, or medical bills.
A HELOC, or Home Equity Line of Credit, functions like a credit card, except that the borrower is using their home as collateral. Similar to a credit card, banks set the limit and the homeowner can take advantage of it when they’re ready. A HELOC is a revolving line of credit that a consumer can draw on, pay back and repeat for a set period of time, usually 10 years. It typically starts with an adjustable-interest rate followed by a fixed-rate period. When the draw period ends, the payment period ensues—usually 20 years—and together, the lender and homeowner decide on a repayment schedule as long as minimum monthly interest payments are made consistently.
1. What is a HELOC?
A HELOC, or home equity line of credit, is a type of loan product that’s available for homeowners. Commonly categorized as a second mortgage. Instead of borrowing a lump sum all upfront, a HELOC allows the borrower the option to withdraw it and use it when they want.
For example, if you qualify for a $100,000 HELOC, you can borrow up to $100,000, either in a lump sum or take out several smaller loans as long as the total doesn’t exceed the maximum credit limit, in this case, $100,000.
Once the money is repaid, you can borrow it again. Repayment is the amount drawn plus interest. Your lender will give you a line of credit that allows you to spend up to your maximum HELOC loan amount.
Homeowners can qualify for a HELOC by owning and having equity in their homes. Simply put, this means, that the value of your home is higher than what you have left to pay on your mortgage. A HELOC is secured by the value of your house, so in the event the borrower defaults on the loan, the lender can seize the property.
Not all consumers can qualify, so to ensure that the borrower can repay the loan, standard credit and income checks apply. Typically, HELOCs are easier and quicker than conventional mortgage loans because they’re backed by the equity you have in your home.
HELOCs are loans that are paid back with interest. Each lender’s interest rates vary. To figure out if a HELOC is right for you, contact your local PERL lender for more information.
2. Why get a HELOC?
There are many benefits of a HELOC, one of them being that it’s a flexible and convenient way to borrow money when you need it. By the same token, you can avoid repaying unnecessary interest since you have the option to borrow in smaller amounts over time. If you think you might need additional funds, but aren’t sure of how much exactly, a HELOC offers borrowers the flexibility of a credit card but with much lower interest rates.
HELOCs may have the added benefit of lowering your taxes because up to $100,000 is tax deductible. *Consult a tax adviser for further information regarding the deductibility of interest and charges.
HELOC loan rates and costs
HELOC interest rates are typically a fraction higher than standard mortgage interest rates and ebb and flow as the market goes up and down. What this means for the homeowner is that their monthly payments can go up and down. As adjustable-rate loans go, a borrower can get a lower rate than standard fixed-rate home equity loans, though their rates can fluctuate regularly.
Other added benefits of a HELOC are that the setup costs are usually lower since the overall process is easier. And during the repayment phase of a HELOC, lenders usually establish provisions that allow the borrower to convert your loan balance to a fixed-rate loan by locking in a rate down the road. Best practices are to never borrow more than 80 percent of your home’s market value, so in the event of an economic crisis, you have at least a 20 percent cushion.
Talk to your local PERL loan officer before paying off the balance of your HELOC loan to be sure you’re not penalized for early termination.
3. The Key Differences Between a HELOC and Home Equity Loan
Home equity line of credit vs. home equity loan
HELOCs and home equity loans are quite similar. They’re both loans secured by the equity you have in your home, however, the key difference is in how the money is distributed to the borrower. A home equity loan gives you the money in a lump sum, while a HELOC gives you the flexibility of receiving smaller amounts over time.
Another key difference is that with a home equity loan the monthly payments will remain the same, while with a HELOC, the monthly payments will vary. As you borrow the same amount of money you’ll end up paying more long-term, as the payments will eventually rise.
HELOCs were created with convenience in mind. A HELOC could be a great option for homeowners that are uncertain of how much they want to borrow and prefer to withdraw multiple small loans over a period of time.
HELOCs have plenty of upsides; but every borrower’s financial situation is different. As with most financial tools, you need to consider the pros and cons of whether a HELOC is the best loan option for your needs. Contact your local PERL lender to discuss all your mortgage needs.