What Is a HELOC Loan?
A home equity line of credit, also known as a HELOC, is a type of loan that uses the value of your home as collateral. This loan is often used by people who need money for a big purchase or for debt consolidation. In this article, we’ll discuss what is a HELOC loan, before you make a decision on whether this is the right type of loan for you.
By the definition, this is a loan that lets you borrow money against the value of your home up to a certain limit. It is a type of secured loan because your house serves as collateral. You can then use funds you’ve borrowed for any purpose. It can be a good option if you need money for a large purchase or want to consolidate debt you’ve collected in past. Goes without saying that taking out any loan comes with many risks, but be really careful if you plan on taking this one. If you end up halting the loan you could lose your house.
This loan can be a great option if you first take the time to understand how exactly it works before applying.
How Does a HELOC Loan Work?
A home equity line of credit (HELOC) is a type of loan that lets you borrow money against the value of your home, putting the house as collateral in case you cannot repay it. This loan and the amount of money you get are approved based on the home equity you have. Simply put, the more of your mortgage you paid off, the more funds you’ll get. Other things that are taken into consideration are how much is your house worth and what percentage your lender will allow you to borrow.
If you are considering applying for this loan here are two HELOC calculators to help you get an idea of what you can borrow.
Your home’s current value x percentage of value lender allows you to borrow = Maximum amount of equity that could be borrowed
The maximum amount of equity that could be borrowed – Remaining balance on your mortgage = Total amount you can borrow
The funds you borrow can be used for any purpose, and you only have to make monthly interest payments until the repayment period ends. After this period, the entire loan must be paid back in full.
What’s the Difference Between a HELOC and a Home Equity Loan?
If you’re thinking about taking out a loan against the equity of your house, you may be wondering what is the difference between a HELOC vs home equity loan.
Both of these loans allow you to borrow money against the value of your home, but there are some differences you should think about while deciding which one might be more suitable for you.
A home equity line of credit (HELOC), is a type of loan which gives you an open account which you can draw funds from as needed. This means it is a good option if you need flexibility in how you use the funds or you’re not sure how much money you’ll need. This loan also has variable interest rates, so you should keep in mind they can go up and down during your term.
Alternatively, a home equity loan is a lump sum loan that you receive all at once. With this loan, you will have a fixed monthly payment for the whole time. They also have a lower interest rate. Because of the type of payment, if you find yourself needing more money in the future, you’ll have to apply for a new loan.
Before you make a decision on which option is better for you, take into consideration for what purpose you are borrowing the money, how much you’ll need and whether you’ll need more.
What Are the Benefits and Drawbacks of a HELOC Loan?
A HELOC loan can be a great way to get access to the funds needed for things like home improvements and renovations or debt consolidation. Now that we explained how HELOC loans work, let’s look at some pros and cons of them.
- Lower interest rates – Because these loans have collateral to secure them, lenders typically give better offers on these less risky loans.
- Flexible terms – With this loan, you can choose a repayment schedule that is the best fit for you.
- No penalties – With a flexible payment schedule, you also have the advantage of paying your loan early without extra fees.
There are a few drawbacks that you should think about before taking out this loan and they include the following:
- Your house is a collateral
- The interest rate varies throughout the term
- Annual or monthly fees can add up
How to Qualify for a HELOC Loan?
Let’s discuss some HELOC loan requirements in order to be able to qualify. First, you will need to have equity in your home. Your home must be worth more than the amount you owe on it. This amount of equity will determine how much you can get from this loan deal.
Moreover, you’ll also need a good credit score and income in order to even be able to qualify. With a good credit score comes better interest rates on a deal. Your income will serve as an indicator to your lenders that you can pay monthly installments.
Is a HELOC Loan a Good Idea?
Depending on your needs and goals, getting this loan can be a good idea.
The funds secured this way could be used for anything you want. Many people choose to use it for home renovation but that doesn’t have to be the case. Let’s say you need money to cover your medical bills. Choosing this type of loan will secure you a better deal than personal loans or credit cards because those have a higher interest rate.
HELOC loan rates can vary but you can still get a good deal.
Alternatives to HELOC Loan
There are a few alternatives that you can think about if you need money for your home or other expenses but aren’t sure HELOC is the right type for you.
Home equity loan
We already talked about these fixed-rate loans that will provide you with a large amount of money all at once. This money can also be used for anything you want but could be a bad option if there is a possibility that you’ll need more money in the future.
They usually have higher interest rates but are not that hard to qualify for through your bank or lender.
Even though they can be difficult to qualify for, it can be a good option because of their low interest rate and good terms. But keep in mind that they may not be able to provide you with all the funding you need.
Line of credit
You can get a line of credit from your bank or credit union. Credit score plays a key part in getting this loan. Same as HELOC you will have an account you can draw funds from when you need them.
In case you ever find yourself in a need of funds to finance a major project, medical bills, or consolidate your previous debt, this type of loan can be a good fit for you. Like any other loan, there are some pros and cons to this one as well. Before you apply be sure you’ll be able to pay the monthly fees because in case you don’t you could end up losing your house. Also, don’t forget that with this loan your interest rate will fluctuate so you could end up paying more than you anticipated. If you only need to borrow a small amount of money, you may want to consider another type of loan.
However, if you think this is the right type of loan for you, be sure to first talk to your financial advisor and compare offers from different lenders just to be sure you’ll get the best HELOC loan deal.