DOs and DON'Ts of Home Equity Lines of Credit
With Spring right around the corner, many credit union members might be thinking about cleaning house, or perhaps, renovating and improving house. A home equity line of credit, or HELOC, may be a sensible way to finance these home improvements and more. However, before delving into the world of HELOCs, it is important to determine if this is the appropriate solution to suit your financial situation and needs.
Read on to learn more about the DOs and DON’Ts of HELOCs and see if this financial tool is right for you. While it is a flexible lending option and can be a good tool for those who have equity in their home and are financially savvy, it can also be risky since failure or inability to repay what was borrowed could result in losing your home.
Home Equity Loan vs. HELOC
Prior to going with a HELOC, credit union members should understand the differences between a Home Equity Loan and a HELOC, and determine which option is better for them.
A home equity loan allows you to borrow a percentage of your home’s value, at a fixed rate and specified term, to use for various purposes. The borrower gets the money in a lump sum and uses it as their leisure, paying the same amount every month.
A home equity line of credit is simply a line of credit based on the equity you’ve invested in your home. The borrower can use money from the line as needed or all at one time by writing a check in the amount desired. Also, the interest rate on a line of credit is variable, unlike the locked-in rate on a home equity loan.
Tips on How to Wisely Use & Manage Your HELOC from Credit Unions Online
If you have decided that a HELOC is a good financing option for you, it is important to know how to use it to your advantage.
- Do use it for:
- Emergencies – HELOCs are good for a rainy day fund in the event of job loss, unforeseen medical expenses, and the like.
- Capital Investments – If you have disposable equity, many financial experts would encourage you to use it toward major home improvements like kitchens and bathrooms which add value to a home, childrens’ education, or a business plan.
- Real estate – A real estate investment property is a great idea for HELOC funds as long as the income from rent pays for the cost of the line.
- Debt consolidation – Paying off major high-interest credit cards is recommended as long as you plan to rid yourself of the cards/accounts that got you into debt in the first place.
- Do not use it for:
- Luxury items such as lavish cars or other vehicles, expensive electronic equipment, vacations, etc.
- Consumables that include daily necessities like clothing, food and other grocery items, etc.
- Paying monthly bills like utilities, mobile phone, etc.
- Any other basic expenses that should be included in your household budget and do not give you a return on your HELOC investment.
- There are costs associated with a HELOC, much like when you purchase a home. You should be aware of and familiar with these costs, including:
- Application fees
- Property appraisal fees
- Up-front charges, such as ‘points’
- Closing costs
- Transaction fees for withdraws
- Yearly maintenance or membership fees
On the bright side, HELOCs generally have lower interest rates than other loans which may offset some of these other costs, and some lenders will waive certain fees or closing costs. Even better, the interest on these lines may be tax-deductible (a tax advisor should be consulted).
- Have a solid repayment plan in place with your lender by being up front, asking (and answering) these questions:
- What will your monthly payment be? Will you be paying principal and interest or will it be an interest-only payment? Will the amount you are paying on a monthly basis be enough to cover the entire principal by the end of the term? The monthly amount you plan to pay on your HELOC should be strategically worked into your overall budget. Also, keep in mind that if you are only paying interest, you will still owe the full principal amount at the end.
- How much will you owe when your payment plan ends? No matter what your HELOC agreement was, when your plan ends, you must pay the remaining balance, also called a ‘balloon payment” in full and should be prepared to do so.
- How will you manage the remaining balance? According to the Federal Reserve Board, this "balloon payment" may be paid by refinancing it with the existing lender, by obtaining a loan from another lender, or by some other means. However, if you are unable to make the balloon payment, you could lose your home.
- Are you prepared for fluctuating interest rates? As mentioned earlier, most HELOCs feature a variable interest rate, meaning your monthly payment could change. In the event that the rate rises, your monthly payment will increase and you should be able to compensate for that difference.
- What are the effects of selling your home while you have a HELOC? Should you decide to sell your home during the time you have the HELOC, you will most likely have to pay what you owe, in its entirety, right away. Therefore, if you are thinking of selling your home, a HELOC may not be the best way to go at this time.
If you are thinking about a HELOC but have questions or concerns, there are resources available to help educate and guide consumers. Some helpful sites include www.federalreserve.gov and www.ftc.gov. Or, you can contact your credit union’s lending department for some trusted advice and insight on obtaining and managing your future HELOC. Not a credit union member? Find a credit union and join today!By Cyndi Cohen
Published March 6, 2012