A home equity line of credit (HELOC) can be a great tool for homeowners needing extra cash to cover things like home renovations, college expenses, debt consolidation, and more. Though HELOCs are common financial products offered by credit unions and banks, many borrowers still don’t know much about them.
Have you ever wondered about home equity lines of credit? You’ve come to the right place! In this article, we’ll take a look at HELOCs and break down some of their common misconceptions.
Why get a home equity line of credit?
Like a home equity loan, a HELOC allows you to borrow money against the equity that you have in your home. However, there’s one major difference.
A home equity loan is a lump sum amount, but when you’re approved for a HELOC, you’ll be given a credit limit. Instead of getting your money all at once as a one-time loan, you will be able to draw funds as you need them.
The benefit to this is that you only have to pay interest on the amount you actually use— not the entire amount that you were approved for. This type of loan can be useful in situations when you aren’t quite sure exactly how much you’ll need or when you’ll need it.
Because your line of credit is secured with your house, HELOCs have several notable advantages. For one, they can be easier to qualify for and have less-stringent credit requirements than unsecured loans. Secondly, you can typically get better interest rates than you would with a personal loan.
7 HELOC Misconceptions
There are some misleading assumptions about HELOCs floating around out there. Read on to learn about why these seven myths are false.
Myth #1: You can only use a HELOC to pay for home improvements.
Not so! While you certainly can use the money to upgrade your kitchen or put in a new bathroom, you can also use it to fund a college education, buy a second property, pay for medical expenses, pay off higher-interest rate debt, or finance a large celebration like a wedding, among other things. Just because “home” is in the name and your home is the collateral doesn’t mean it has to be used for your home.
It is worth noting, however, that using your HELOC to cover home improvements does come with special tax benefits. Interest on home equity loans and HELOCs is tax-deductible if you use the funds to buy, build, or substantially improve your home. Keep in mind that in order to be deductible, the funds must be used on the property in which the equity is the source of the loan.
If you plan on deducting your interest payments, always be sure to speak with your financial institution or a tax professional to ensure that you do indeed qualify.
Myth #2: There is no difference between a HELOC and a home equity loan.
While both use the equity in your home as collateral, they are distributed in different ways. A home equity loan provides the borrower with a one-time, lump-sum payment. Home equity loans also follow the format of a traditional mortgage in that payments begin immediately for a loan term of of 5, 10, 15, or 20 years.
A HELOC parcels out the money on an as-needed basis at the request of the borrower. HELOCs have a variable interest rate, so whatever you are being charged is subject to periodic changes throughout the life of the loan. HELOCs also have a draw period— typically 10 years— during which a borrower need only pay down on the interest. The principal must be reduced to zero in the second 10 years.
Myth #3: HELOCs cannot be paid off with minimum monthly payments.
During the draw period, you need only to make payments on the interest. Once the second 10-year period begins, you must stop drawing on your line of credit and begin paying down the remaining interest and principal. You will be given a set payment every month allowing you to pay off the loan in 10 years.
Myth #4: Getting a HELOC can damage your credit score.
Having an open line of credit will not damage your credit score. What will cause your score to nosedive, however, is not making timely payments on your HELOC. If you’re punctual, it will actually help your credit score by showing that you’re a trustworthy borrower.
Myth #5: A HELOC is a good way to provide overdraft protection for a checking account.
Having a HELOC in place doesn’t provide automatic overdraft protection for the checking account you might have with the lending institution. You will have to make separate arrangements to make sure your overdrafts are covered properly, or choose a credit union with no banking fees—like Amplify Credit Union!
Myth #6: HELOCs are not available to those who have just purchased their home.
The equity in your home is available to you to use as collateral immediately upon taking possession of the property. Most people who have owned their houses for longer have built up more equity, but there are no minimum ownership duration requirements attached to getting a home equity line of credit. So, if you made a sizable down payment, you can immediately begin drawing upon the equity it provides.
Myth #7: A HELOC is a great way to finance an auto or truck purchase.
This is a bad idea for several reasons. First of all, depending on your credit score, you could potentially get a much lower rate on a car loan— especially if a dealer is running a special on a model they are trying to move off the lot. Second, HELOCs and home equity loans have much longer payment periods than car loans do. You don’t want to be paying for your car 10 years from now! And finally, most vehicles lose value every year while homes mostly gain it. You don’t want to finance a depreciating commodity with an appreciating one.
Use Your Home Equity
Ready to turn your home equity into cash on hand whenever you need it? Reach out to Amplify Credit Union to learn more about HELOCs, home equity loans, and other financial products to determine which one is right for you.