Tapping into your home equity is a very convenient way to obtain a loan that can be used for many different things, like a home renovation project or to help fund college expenses.
If you are considering using your home’s equity to get a loan, a popular option to consider is a home equity line of credit (HELOC).
But, are HELOCs a good idea?
These loans are very different from traditional loans, and it’s important to understand how they work and their pros and cons before deciding to apply for one.
What is a HELOC?
With a conventional loan, you receive a lump-sum payment for the total loan amount up-front and then repay it over time with monthly payments. A cash-out refinance is an example of a home equity loan that you repay over time with either fixed or variable rates.
With a University Credit Union HELOC, you receive a line of credit instead of a lump-sum amount up-front. HELOCs operate similarly to credit cards. They allow you to withdraw money as you need it, and the amount of available funds is replenished as you repay the money you borrowed.
HELOCs are typically established for a certain period of time, which is called the draw period. University Credit Union offers a draw period of 10 years. They also usually have minimum amounts that you can borrow. With University Credit Union’s HELOC, for example, the minimum borrow amount is $25,000.
There are many situations where a line of credit may be preferable to a lump-sum payment. This type of loan is a good option for those who are completing home improvement projects themselves and they need a way to periodically obtain money for building materials, tools, and other supplies.
Pros of HELOCs
HELOCs have many benefits to consider. These are the reasons why HELOCs are a popular option for those who are looking for a way to tap into their home’s equity.
Few restrictions on how you use the funds
HELOCs typically have few or no restrictions on how funds can be used. In most cases, how you use the money is entirely up to you.
Borrow only what you need
Unlike a conventional loan where you receive the full amount of the loan upfront and then repay it over time with monthly payments, HELOCs allow you to borrow only the money you need, when you need it. Some people take out HELOCs and never make withdrawals. They keep their lines of credit open for emergency purposes.
Interest may be tax-deductible
Although the tax code changes every year, you may be able to deduct the interest from your HELOC payments on your tax return. Be sure to consult with a tax professional for the current IRS regulations on interest deductions for more information.
Low interest rates
Interest rates for HELOCs are usually lower than rates for personal loans or credit cards, which are unsecured. HELOCs are secured loans that are backed by the equity in your home.
There are several ways to get the best HELOC rate. Although HELOCs already have great rates, it pays to do your homework before applying to make sure you get the best rate possible.
Interest-only payments
You can make interest-only payments on the money you borrow during the draw period. This can be helpful for a home improvement project that will increase the value of your home. If you intend to sell the home after completing the project, the profit may be used to repay the principal of the loan.
Cons of HELOCs
While the benefits of HELOCs are hard to ignore, there are some potential negatives to consider.
Evaluating both the pros and the cons will help you make an informed decision as to whether this is the best loan for your needs, or if another type of loan would be a better choice.
Your home is used as collateral
While the use of your home as collateral to obtain a low interest rate may be viewed as a valid HELOC benefit, it can also be a negative at the same time. One reason for this is because when you use your home as collateral, the equity in your home will be reduced by the amount of money you borrow.
Another negative to consider is the potential loss of your home if you are unable to repay the principal when the draw period ends. In the event of financial distress, there is a risk that a borrower may lose ownership of the collateral that was used to secure a loan if the borrowed money plus interest cannot be repaid.
Variable interest rates
Most HELOCs have variable interest rates. This could result in spending more on interest than what you anticipated if the interest rate increases.
Possible balloon payment
If you have been making interest-only payments during the draw period, the full amount of the borrowed money will be due when the draw period comes to an end. This could result in a balloon payment to cover the debt. UCU’s HELOC has a total term of 25 years. The first 10 years is the draw period. On the day that the draw period ends, if the balance is zero, the HELOC is closed out. If there is a balance, the member will have the remaining term — 15 years, in this case — to repay the loan. The last 15 years is the "repayment" period.
Fees
HELOCs may have additional fees that go beyond closing costs. Knowing whether a HELOC you are considering has fees can help you avoid unpleasant surprises. Potential fees to be aware of include:
- Annual maintenance fee
- Withdrawal fee
- Non-use fee
- Penalty for early payment
Whether a HELOC has additional fees depends on the lender. University Credit Union’s HELOC, for example, does not have an annual maintenance fee, withdrawal fee, non-use fee, or penalty for early payment, saving our members money.
It’s easy to overspend
Something to watch out for with a HELOC is the temptation to overspend. When you only have to make interest-only payments during the draw period, it can be easy to forget that the principal of the loan will eventually have to be repaid. Because of this, some may treat their HELOCs like an ATM and use them for things that are unrelated to the original purpose – like buying groceries, electronics, furniture, and other things.
A Smart Way to Tap Into Home Equity
HELOCs are a great option for those who need a line of credit instead of a large lump-sum payment. They are ideal for remodeling your kitchen, fixing a leaky roof, or for consolidating debt.
If you are looking for a HELOC with a great rate, University Credit Union has you covered. You can borrow up to 80% of your combined loan to value, and there are no annual fees. With a minimum loan amount of $25,000, you will be able to use it for many different projects and expenses. Applying is quick and easy – everything can be done online.
If you have any questions, one of our representatives will be glad to assist you. You can also read about general HELOC considerations and requirements to learn more about these loans.
Read General HELOC Considerations & Requirements