What is a HELOC and how does it work?

A HELOC (Home Equity Line Of Credit) is a home equity loan that allows homeowners to borrow money against the principal they have written off.. HELOCs can offer flexibility in lending but have limitations.They also carry the risk of foreclosure and can require a lot of discipline..

Whether you need to update your kitchen or fix a leaky roof, an improvement project, or have a home repair done, it probably won’t be cheap to pull it off.

The average cost of a kitchen remodel is between $25,800 and $42,000, according to the 2018 Houzz Kitchen Trends Study. And if you need to replace your roof, the average cost of $7,211, according to HomeGuide data as of December 2019.

Unless you have that amount of money available in your bank account, you will probably need to take out a loan in order to do that remodeling or repair. Maybe you want to consider a Home equity line of credit, or HELOC, which allows you to borrow on the amount you’ve already paid off on your home.

Just like a line of credit, the HELOC allows flexibility in both borrowing and repaying. But it’s important for borrowers to have a lot of discipline when it comes to withdrawing funds and paying back their lenders.

Read on to learn more about the HELOC and some of its alternatives.

How does a HELOC work?

In its simplest form, a HELOC it works like a credit card. You can borrow money up to a certain credit limit set by the lender and then repay the borrowed amounts along with interest. This option can offer more flexibility, you can even withdraw and make daily or weekly payments, if necessary.

What determines the credit limit of a HELOC?

The credit limit on a HELOC depends on several factors, including your credit and outstanding debts, but is largely determined by the market value of your home and the amount you owe on your mortgage.

For example, if you own a home valued at $400,000 and you still owe $300,000 on your first mortgage, then the value of your home is $100,000. Banks typically limit the amount you can borrow to no more than 85% of your home’s appraised value minus what you still owe on your mortgage.

In this case, the maximum amount you can borrow is $40,000. Here’s how it’s calculated, assuming there are no other liens on your home:

  • Market value of the house: $400,000
  • 85% of home value: $340,000
  • Subtracting the mortgage balance: $340,000 – $300,000
  • Possible line of credit: $40,000

How are HELOC funds used?

If you are approved for a HELOC, lenders may allow you to withdraw money during a fixed time known as the withdrawal period..

Once your draw period is over, the lender may allow you to renew the line of credit. If not, you may have to repay the outstanding amount all at once or over a period of time, called the repayment period.

What is the duration of a HELOC?

The length of a HELOC varies, but could last up to 30 years (often with a 10-year withdrawal period and a 20-year repayment period). While borrowers can choose to withdraw available money immediately, lenders can structure HELOC as long-term relationships.

Are there any additional charges?

set your HELOC it could cost hundreds of dollars in fees. Here are some:

  • Evaluation fees
  • Application fees
  • Charges in advance, such as points
  • attorney fees
  • Title Search Fees
  • Mortgage preparation and presentation
  • Annual quota
  • The transaction fees.

Many of the terms and fees of HELOC are determined by the lender. For this reason it is advisable to investigate these details before entering into any agreement. Some conditions might even be open for negotiation.

Do not forget that you will also pay interest. While most of the HELOCs offer variable interest rates, they can also be offered with introductory rates, which are usually lower than normal rates but are temporary. You must search and compare.

The risks of a HELOC

There are several risks with HELOC, but one of them is very clear. Because it uses your property as collateral, defaulting on payments could result in the loss of your home.

Banks have put limits on the amount you can borrow to minimize the risk of loss, but it still exists if you can’t make the required payments.

There is another risk with HELOC: your lender may have the ability to reduce or freeze your line of credit. Lenders typically only do this if there are late payments, changes in your home equity, or in the midst of a financial crisis, but it’s still a possibility worth considering.

Even when they do manage to avoid unforeseen personal problems, loan borrowers HELOC they might have to deal with market trends.

The interest rate of a HELOC It is usually variable and can change. It is often tied to the prime rate and can be affected by changes in the market over the life of the loan. HELOC.

However, there may be limits to that uncertainty, such as a periodic cap (a limit on rate changes at a given time) or a lifetime cap (a limit on rate changes over the term of the loan).

Some alternatives to a HELOC

If you are considering a HELOC but you’re not sure if that’s the right solution for you, here are some alternatives to consider.

Home Equity Loans

Home Equity Loans and HELOC they have similarities. But you need to know that these two products are actually different. And some of these differences could determine which option might be better for your needs.

Include table in this place

HELOC Home Equity Loan
Equity Leverage home equity Leverage home equity
Warranty The house is the guarantee The house is the guarantee
Money Available up to the credit limit during the withdrawal period to access the funds you need Paid in a lump sum, in advance
Interest rate Usually a variable rate Usually a fixed rate
Payments Payments are made only on the amount borrowed once the funds are withdrawn Payments are made periodically during a time limit

The HELOC and home equity loans are similar: both involve borrowing against the home equity and using the home itself as collateral. The differences between a HELOC and a home equity loan may seem small; however, they can be crucial when it comes to getting into debt.

For example, a home equity loan does not allow a revolving line of credit as a HELOC. Instead, the loan amount is taken out as a lump sum up front and paid back piecemeal over time (plus interest) using a set repayment schedule. This structure can be useful for people who know exactly how much money they need and when they will be able to pay it back.

A home equity loan also usually has a fixed interest rate, which can provide more security. This can allow you to do better planning when creating a budget or loan repayment plan. On the downside, the stability of that fixed rate generally means a higher rate than you can get on a HELOC..

Cash refinancing

A cash refinance also involves borrowing money against the value of your home, but requires a full refinance of your mortgage rather than entering into a side agreement.

This can be a good way to consolidate debt or finance the same types of expenses you’re looking to pay with a HELOC loan or home equity loan.. But it could also leave you with a higher interest rate on your mortgage and the obligation to pay closing costs.

personal loan

If you don’t want to eat up the equity in your home or use it as collateral, then you might consider a personal loan.

Although secured personal loans involve the contribution of some guarantee, you can contribute other assets and not your house, such as a savings account or a car. Secured loans can offer quality terms and conditions to people with good credit who don’t want to risk losing their home. You can also consider an unsecured personal loan, which is not backed by collateral.

However, unsecured loans have a downside: lenders consider them riskier than secured loans, so they are likely to charge you a higher interest rate..

conclusion

Before requesting or managing a HELOC, consider what you will need it for. If you plan to use a HELOC For home improvements, think about setting a budget and saving for improvements over time, rather than borrowing money.

Create a budget and make sure the monthly payments fit your lifestyle.

If you don’t have time to save and want to borrow money, also consider other financing options like a personal loan or a home equity loan.. Take into account fees, payment schedules and interest rates to make the best financial decision for you.