Things to Know About a HELOC
Great work — you’ve managed to accumulate some equity in your home. Perhaps you’ve paid down the mortgage diligently, or maybe the property’s market value has gone up since you bought it. Either way, the amount you owe is considerably less than what you could get for the place in a sale.
Many homeowners in this situation find that a home equity line of credit, or HELOC, can be a good way to use their home equity to finance renovation projects, a child’s college tuition or other large expenditures. For one thing, the interest can be tax-deductible, which lowers the cost of borrowing.
But there are seven things you should know about HELOCs before you sign on the dotted line.
1. What is the cost?
With most lenders, you can expect not to pay closing costs when you open a HELOC. However, some lenders will charge a penalty fee for early closure of the HELOC account.
2. Qualifying requires documentation
Lenders want to know that you’re a solid candidate for a loan when you apply for a HELOC. They’ll check your credit report, your income and statements from your major financial accounts.
3. You only pay for what you use
You won’t pay a cent of interest unless you actually borrow money using the line of credit. This makes a HELOC ideal if you have a big expense coming up but you don’t know exactly how much you’ll need or when.
4. The interest rate can vary
Unlike with home equity loans, which often have fixed rates, the annual percentage rate on a HELOC typically can go up and down according to the market. Lenders like Cornerstone Financial Credit Union can help you understand how a HELOC’s interest rate may change over time.
5. There are borrowing limits
Lenders typically limit equity borrowing to no more than 75% to 85% of your home’s appraised value, including the mortgage. That way, if the market drops, you’re less likely to wind up owing more than the home is worth.
6. The credit line can be frozen
If your home’s value declines significantly, the lender can reduce or freeze the line of credit, which may limit or prevent you from using it. Usually this occurs only if the lender determines that you’ve become a riskier borrower.
7. Foreclosure is a risk
A HELOC uses your house to secure the debt. So if you fail to pay what you owe, you risk facing foreclosure.
Used wisely, a HELOC can be a powerful tool for unlocking your home equity without selling the place. But make sure you’re not using it for a risky investment or frivolous purchase. The value of your home is an important part of your financial security.
Virginia C. McGuire, NerdWallet