A home equity line of credit (HELOC) is a second mortgage that uses your home’s equity as collateral. It’s similar to a home equity loan. But rather than receiving a lump sum of cash, you gain access to a credit line up to 80% of your home’s equity. You can withdraw cash on an as-needed basis and use the money for many purposes from paying for college to home improvements. A HELOC may seem like a good idea if you have plenty of equity, but you have to consider whether this is the right choice for you.
Can you afford the monthly payment?
Before getting a HELOC, take a look at your monthly cash flow and determine whether you can afford another monthly payment. And if you can, how much can you afford?
Money you receive from a home equity line of credit isn’t free money. It’s a second mortgage, so you have to repay borrowed funds. Monthly payments are based on your interest rate and how much you withdraw from the account. With cash so readily available, it can be tempting to take large sums from your account. However, it is imperative that you calculate the cost and only borrow what you need. Your home serves as collateral for the HELOC. If you default and stop making payments, the bank can foreclose.
Consider your future cash flow
HELOCs have a draw period up to 15 or 20 years. Many home equity lines of credit have a variable interest rate, meaning the rate can change according to the market. You may receive a low rate today, resulting in low minimum payments. But if your rate increases in the future, so do your minimum payments depending on how much you owe at the time. Regardless of why you need funds, come up with a plan that lets you pay off the line of credit as soon as possible, just in case your rate increases.
How’s your credit score?
You don’t need a perfect credit score to qualify for a home equity line of credit, but your credit rating can affect your interest rate. Before applying for any type of loan or line of credit, pull your credit report and check your credit score. Check your report for errors and make any needed improvements, such as paying all your bills on time and paying off debt. Both efforts can improve your credit score and help you qualify for a better interest rate.
How’s your local real estate market
A HELOC can provide the cash you need if your property has substantial equity. But it’s smart to evaluate your local real estate market before applying for a line of credit. If home values in your area have been on the decline in recent years, getting a home equity line of credit could be dangerous. You might have plenty of equity at present, but if home values were to fall, you could lose your equity. Remember, getting a HELOC reduces the amount of equity in your home. If you borrow against your equity and your home value drops, you could end up owing more than your property’s worth.
