When is a line of credit on your mortgage the best choice?
If you want a line of credit to cover home renovations, a new car, your child’s college education, or even debt consolidation, a home equity line of credit, or HELOC, can be a great option.
“A home equity line of credit, or HELOC, is a mortgage loan in which the lender agrees to lend a maximum amount within an agreed time frame, where the collateral is the borrower’s equity in their home,” said explained First Bank CEO Patrick Ryan. “It’s a line of credit secured by the borrower’s home that gives them a revolving line of credit.”
How does the revolving line of credit work?
With a traditional HELOC, as the outstanding balance is paid off, the amount of available credit is replenished — much like a credit card, Ryan said.
“This means you can again draw (advance) against the line if needed throughout the draw period up to the approved credit limit,” he said.
In general, lenders offer different ways to access these funds, whether by online transfer or by check.
“At the end of the draw period, the repayment period begins during which the line is no longer available for draws/advances and will be required to repay any amount owed,” Ryan continued.
When is it advantageous to take out a line of credit, why and what are the advantages?
HELOCs can be used for home improvements, major purchases, consolidating debt from credit cards and higher interest loans and tuition.
“Rates are generally competitive, very low and variable tied to an index like the prime rate,” Ryan noted.
Usually, he said, HELOC rates will match the index rate with no added margin or some lenders will add a 0.25% to 1% margin to the index.
“Compared to unsecured sources of borrowing, such as credit cards, borrowers will pay less finance charges for the same loan amount,” Ryan said.
Borrowers will need to qualify for a HELOC, and lenders guarantee HELOCs like other home loans, he noted.
“They have guidelines that dictate how much they can lend based on the value of the property, the equity available and the creditworthiness of the borrower,” Ryan explained.
Is it better than using a credit card?
According to Ryan, in general, HELOC rates are much more favorable than credit card rates, as credit card rates can be as high as 24%. With a HELOC, he said, borrowers will pay less finance charges for the same loan amount. Also, there may be tax advantages with a HELOC, as the interest may be tax deductible. Be sure to consult a tax advisor to be sure.
“When someone takes out a personal loan or borrows on a credit card, for example, not only will they pay a higher interest rate, but they won’t be able to claim a deduction on their taxes,” Ryan said.
Even though interest rates are likely more favorable by having a HELOC, the equity in your home will be affected.
“A HELOC is an accessible account that you can access against the equity in your home and it can work like a checking account where you write checks or transfer funds from a HELOC,” said Nicole Rueth, vice- Senior President of Fairway Independent Mortgage Corporation. “As you spend that money, it reduces the amount of equity in your home. Those funds will need to be paid back as a mortgage payment if you refinance or sell your home.”
But, you can continue to borrow if you need to. Rueth said once a HELOC has been opened, it has a 10-year drawdown period allowing the owner to access the funds without having to qualify again.
“It can give someone peace of mind when they need money in an emergency,” she said.