By John Campbell
If you need a sizeable credit line and own your own home, you can use the equity in your home as collateral for a revolving line of credit. A Home Equity Line of Credit (HELOC) may have much better interest rates as well as a credit line that is larger than many credit card lines of credit.
If used to consolidate debt, a HELOC can be an excellent way to combine several smaller debts into one lump sum. A HELOC can also save you a lot of money over what you would pay on your various debts individually. Using your home as collateral, you may be able to open a line of credit worth tens of thousands of dollars. Being approved for a HELOC is often much more complicated than being approved for other lines of credit, however.
The process of being approved for a HELOC is similar to being approved for a mortgage. To find out if you qualify for one of these loans, a lender will have your home reappraised, take a percentage of the current appraised value of the home and subtract what you currently owe on it. This will determine how large your credit line may be. For example, if the lender uses 80 percent of the appraised value of a $185,000 home and subtracts the $120,000 you owe, you may be approved for a line of credit as high as $28,000. The final amount you may be qualified for will also be determined by your current debt-to-income ratio and overall credit history.
As with a mortgage, there are a variety of fees associated with a HELOC that you may be responsible for paying. These include:
• Home appraisal fees
• Application fees
• Points paid upfront to lower the interest rate
• Closing costs
There may also be annual fees, transaction fees and any number of other fees associated with a HELOC. The costs of this line of credit could change over time as many HELOCs have a variable interest rate. The interest rate is typically based off of one of several different indexes coupled with a marginal fee, which the lender makes money off of. If interest rates stay low, you’ll get a decent interest rate on your HELOC. If rates go up drastically in a short period of time you could end up paying a lot more in interest than you bargained for.
Luckily, you’ll be protected from rising interest rates to a certain extent. A number of laws place caps on the amount of interest that can be charged on a loan drawn on your home. If the rates ever hit the cap you may be temporarily limited in how much credit you’re allowed to use and may even be prohibited from using your credit until rates stabilize. This helps protect you from overextending yourself and risking foreclosure.
In addition to restrictions that may be placed on a HELOC, you may be required to take out a set minimum amount of cash each time you use some of your credit. You may also be required to have a minimum amount of the credit line outstanding at all times. In regards to payouts, a HELOC is often paid out from blank checks in your name or from a credit card that draws on your line of credit.
A HELOC is usually established in your name for a set period of time; often up to 10 years. If you sell your home your HELOC will be closed. When the credit line is closed you’ll more than likely be responsible for the immediate payment of any remaining outstanding balance in full. If you can’t renew the line you may have to take out a separate loan just to pay off the proceeds of your HELOC. Fail to pay off the remainder of your balance due and you could lose your home. To avoid being stuck with a sizeable lump sum payment at the end of your loan term you should always pay more than the minimum required payment every month.
As with any line of credit, no two HELOCs may be the same. You need to take into account all of the fees, the index that may be used to determine your interest rate and all of the various terms and conditions before deciding if a HELOC is right for you. If you ever sign up for a HELOC and have second thoughts, you have three days to cancel your account according to the Truth in Lending Act. If you cancel within that time frame you can also get all fees used to start the line of credit refunded.
HELOCs can be quite useful if used to consolidate debts or make very large purchases. Otherwise, you may be better off getting a credit card. Regardless of your choice, getting a HELOC is not something to be considered lightly. Fail to pay it off and the ultimate price could be your home.
© cashbuzz.com
John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances. This article may be reprinted on your Web site if the copyright, author information and active link are included.
