How does a HELOC work?
A home equity line of credit (HELOC) is a line of credit that is secured by your home. Basically, when you own your own home, you build equity in that home as you start to pay down the mortgage and your home’s value becomes higher. A HELOC allows you to borrow money, up to 65 percent of the value of your home minus what you owe on it.
What are the benefits of a HELOC?
“The greatest benefit of a home equity line of credit is that it is flexible,” said Carrick Lai, Director of Residential Real Estate Secured Lending, ATB Financial. “Once you apply for it and it’s approved, it is always there when you need it. You can borrow from it whenever you want and can pay it back whenever you want with no penalties for repaying it early.”
When you have a home equity line of credit, you can borrow from it whenever and as often as you need to. Whatever value you’ve repaid into it, you can borrow over and over without having to apply or re-qualify for the loan again. You can choose to pay down the principle of your HELOC as much or as little as you want, and you’re only required to pay the minimum interest payment on the amount borrowed each month.
Another major advantage of a home equity line of credit is that interest payments are usually lower than a typical line of credit or personal loan.
Why are interest rates on a HELOC lower?
That means the bank uses your home’s equity as collateral for your HELOC. They can offer lower interest rates because if someone defaults on their payments, and is unable to pay back the loan, the bank can force the sale of their property and reclaim the money. This is a rare occurrence, but having this collateral makes it less risky for the bank, thus the lower interest rate to the borrower.
What can I use a HELOC for?
There are many reasons why you might consider a home equity line of credit. To pay for home renovations, purchase a second property, buy a new car, or go on vacation.
“Another way people use a HELOC is to consolidate several high interest debts like credit card debt, car loans or other personal loans,” said Lai. “They can put those all together, pay them off with the home equity line of credit, and give themselves lower payments at a lower interest rate.”
When is getting a HELOC a bad idea?
“Typically, the amount of money available in a HELOC would be much larger than a regular loan or personal line of credit,” said Lai. “If someone is not great at managing their own finances or doesn’t have a budget, having that much money available to them might create too big of a temptation for impulse purchasing and could get them into financial trouble.”
You should not use your HELOC for daily purchases or regular living expenses. If you have struggled with other forms of debt, it might not be the best option for you.
You should also be aware that the interest rate on a HELOC are variable. If and when the prime rate goes up, your minimum interest rate payments will go up too.
“Before taking out a home equity line of credit, you should always talk to a professional to make sure it’s the right fit for you. Make sure it fits into your whole financial plan and that you’re not getting into something you’re unsure of or might regret down the road,” advises Lai.