When homeowners need money to help cover expenses, a HELOC, or a home equity line of credit, is one way to rustle up some extra funds.
A HELOC can be used to pay for major repairs to your home, college expenses or even vacations. It also can be handy for people who need an alternative resource to pay their mounting debts. People turn to HELOCs because they are an easy way to get money they need.
But it is important for homeowners to understand the process of using a HELOC to make sure they don’t end up in financial trouble.
What is a HELOC?
A HELOC resembles a second mortgage, although there are differences. It allows homeowners to borrow money by cashing out some of the value they’ve acquired in their residence through years of mortgage payments and using it to pay various expenses.
It is different from a typical second mortgage because the credit is revolving — like a credit card rather than a traditional mortgage. The interest rate for a HELOC also may be higher than the rate for a standard home loan.
How Does a HELOC work?
A HELOC works a bit like a credit card in that you use your credit as you need it. Borrowers have a pre-approved spending limit. When they need money, they can withdraw cash using an actual credit card or through special checks.
Homeowners will have monthly payments that include interest. Those payments will continue through a fixed term that ranges from five to 15 years. If any money is still owed by the end of the term, the homeowner will be required to pay back the amount in full.
Also, if owners sell their homes while they have payments to a HELOC, they will be required to repay the money they borrowed.
There are benefits to having a HELOC when filing your tax returns. A HELOC can be tax-deductible for homeowners who borrow up to $100,000. The interest you pay toward a home equity loan also can be tax-deductible.
Interest rates can be low, but they also are variable – meaning they can change over time.
HELOCs and Debt
A HELOC can be a solution to rising debts, but it also can become the reason people end up mired in debt. So it is essential that homeowners be clear on both the advantages of taking out a HELOC and the potential problems that can come from it.
If you are using a HELOC to manage existing debt, you should contact a debt counselor and work out a program to manage your finances in a way that leads you out of your debt problem.
People in debt often see a HELOC as an easy solution. Indeed, it can be a backup if emergency funds are not available to help you get through a debt problem. The line of credit can be preferable to using credit cards, which can have higher interest rates and late fees.
A HELOC can add to debt woes, however, if homeowners take out a line of credit on their home to pay off other debts over and over again. This ongoing cycle is called reloading, in which the homeowner must borrow money repeatedly to make ends meet.