Borrowing money from a bank or other lenders is always an important decision, however, the commitment becomes considerably more serious if you need a large amount of money. Furthermore, in many cases, the risks grow with the rewards, but this is not always the case.
Using the equity in your home as collateral for a loan is usually a better choice than applying for an unsecured one mostly because the former comes with considerably lower interest rates than the latter. Not using the equity in your home is basically like throwing away money.
This having been said, there are several types of debt that are guaranteed using home equity, and some are more useful than others. One of the most popular types of debt, to this day, it the HELOC, or home equity line of credit. Here is what you need to know about it:
Understanding what a HELOC is?
Home equity lines of credit and loans are both guaranteed using the equity in your home as collateral, but each of them offers different degrees of financial flexibility. Where a loan implies borrowing a set amount of money for a certain period of time that must be usually repaid on a monthly basis, a HELOC functions largely the same as a credit card.
Generally speaking, a HELOC allows you to borrow money only when you need it. The credit limit on these agreements is considerably larger than that of credit cards. Furthermore, you can use as much or as little of that given credit whenever you want, just like you would if it were a credit card.
It is important to mention that the limit for the line of credit is usually decided by how much equity you have in your home. In most cases, if creditors look at the value of your home and at how much you owe on your mortgage. For example, if you own a $500,000 home and owe $250,000 on your mortgage, the creditors will decide that you have $250,000 in equity in your home, which will also be the limit for the line of credit.
The advantages and disadvantages of a home equity line of credit
While it may seem risky to borrow money that you guarantee for using your home equity, especially when considering that you also have to still make monthly payments on the mortgage, a good budget plan can turn a HELOC into a very useful tool. Home equity lines of credit can only be risky if you take on too much debt, or if you are not financially stable. Here are the main advantages and disadvantages of a HELOC:
- Only pay for what you use – With a HELOC, you only pay interest (monthly) for the amount of money that you use. For example, if you have a $250,000 HELOC, and you use only $20,000, the interest will be calculated on the amount of money that you’ve borrowed. You can repay it by the end of the month and skip having to pay interest;
- Great for general financial security – Provided that you do have the monthly income to keep the line of credit from becoming too expensive, the HELOC can be great if you ever find yourself needing a larger amount of money ASAP. Borrowing money using the line of credit is as simple as using a credit card and does not require you to first go to meetings at the bank or wait for any approvals;
- It is really cheap – A HELOC is often considerably cheaper than a regular loan, especially when considering that you only pay interest for what you borrow. If you take out $200-$500 each month and pay them back after 30 days, the interest will be barely noticeable;
- It can cause you to overspend – Having so much money at your disposal can give you a false sense of security, which may lead to you spending considerably more than what you normally would. It is possible to reach a point where you either won’t be able to repay the money on time and the interest alone will eat a large chunk of your monthly income;
- Using a HELOC requires financial planning – While actually having the HELOC at your disposal is extremely affordable, borrowing money while you are unemployed can lead to big problems in the future, as the debt continues to grow. If the economy is unstable, or you do not have a long-term job, even taking small amounts of money every month, from a home equity line of credit can lead a large debt;
Having a HELOC at your disposal is a great way to ensure that you always have funds to fall back on if you need to pay for unforeseen expenses. It can be useful if you need money to send the kids to college, if you want to do some home improvements, or if you need to pay for medical bills or treatments. There is no limitation to what you can do with the money, however, failing to return all of it at the end of the agreement will lead to you losing your home.