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A home equity line of credit can be the perfect choice if you’re looking for a way to borrow money in small increments for specific purposes. This line of credit acts like a loan but differs in many ways.
Is a home equity line of credit the right choice for you? Well, there are many factors to consider to obtain a solid answer to that question.
What Is a Home Equity Line of Credit?
A home equity line of credit, or HELOC, is like a credit card with your house as the payment. Essentially, your house is what you are putting up as collateral for the credit you need to spend on whatever you need it for. You can check your home equity rate with a loan calculator before you start the application process.
HELOCs provide a line of credit to access whatever amount you want with low-interest rates if you have a high enough credit score. You only pay interest on the amount of money you spend.
Personal and home equity loans can lend you money but appear as a lump sum with higher interest rates than HELOCs. Refinancing your mortgage is another alternative to a HELOC.
Advantages of a HELOC
A HELOC has many pros and cons, so it’s essential to research to find out what’s best for you. Let’s explore some of those advantages for you to ponder.
Flexible Repayment Options
One of the benefits of taking out a home equity line of credit is that many flexible repayment options are available. HELOCs can last up to 30 years, depending on who you borrow money from and how much they lend you.
Once you enter the repayment period, most HELOCs allow you to make payments on the principal to lower your remaining balance. For the first 10 years of your HELOC, you usually only make payments on the interest you accrue.
Higher Credit Score
The potential to raise your credit score is another benefit of a home equity line of credit. Based on the types of credit you have and your payment history, your credit score can rise and drop dramatically throughout adulthood.
A home equity line of credit can significantly raise your credit score with timely payments and better financial decisions. When you first apply, you might see your score drop because lenders perform a hard credit inquiry.
HELOCs differ from other lines of credit and do not figure into your credit utilization ratio. Pay off your credit cards and keep the balances at zero to keep your credit score high while you pay off your HELOC.
Drawbacks of a HELOC
The several drawbacks associated with taking out a home equity line of credit may dissuade you from going that route. Let’s look at what those might be.
The obvious drawback to a home equity line of credit is that you use your house as collateral. This can be dangerous because you risk losing your home if you don’t make the necessary payments. This considerable risk can even result in foreclosure.
HELOCs are secured loans that can drastically reduce your interest rates, but is it worth risking losing your home? If there’s any chance you might not be able to make your payments, you should consider alternative financing options.
Reducing Your Equity
Home equity can take a while to build and is an advantage of owning your home. However, another downside to taking out a line of credit on your home is that you essentially decrease the equity you have in your home.
With the housing market being unpredictable in recent years, it’s a huge risk to take out a home equity line of credit against your home. If prices drop in an unstable real estate market, you could pay much more for your home than it’s worth.
The Bottom Line
A HELOC can be a game changer if you need to make renovations and you can’t afford them. Loans can be tricky and costly, but you could consider a personal unsecured loan if you can get a reasonable rate. However, if you can get a fixed rate with low interest, a home equity line of credit might be the best option for you and your family.