There are some misleading assumptions about a Home Equity Line of Credit (HELOC) floating around out there. Let’s dismiss those notions and explain why they’re wrong.
Misconception #1: You Can Only Use a HELOC to Pay for Home Improvements
Not so! You certainly can use the money to upgrade your kitchen or put in a new bathroom, but you can also use it to fund a college education, buy a second property, pay for cosmetic surgery, put in a pool, 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.
Misconception #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 period of 5, 10, 15 or 20 years.
A HELOC parcels out the money on an as-needed basis at the request of the borrower. HELOC’s do not have a fixed rate, so whatever you are being charged is subject to periodic changes throughout the life of the loan. HELOC’s also have a draw period of 10 years during which a borrower need only pay down on the interest. The principle must be reduced to zero in the second 10 years.
Misconception #3: HELOCs Cannot Be Paid Off with Minimum Monthly Payments
During the so-called draw period, that is, the first 10 years of the agreement, you need only 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 principle. You will be given a set payment every month allowing you to pay off the loan in 10 years.
Misconception #4: Foreclosures on HELOCs are Common
Not so. While a borrower can lose their home for failing to make payments on their HELOC, it is a very rare occurrence in Texas. It’s so rare, in fact; the percentage is usually rounded down to zero.
Misconception #5: Simply Getting a HELOC Can Damage Your Credit Score
Not at all. What will damage your rating, however, is not making timely payments on your HELOC. If you’re punctual, it will actually help your credit score.
Misconception #6: A HELOC is a Good Way to Provide Overdraft Protection for a Checking Account
Having a HELOC in place does not 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.
Misconception #7: HELOCs are Not Available to Those Who Have Just Purchased Their Homes
The equity in your home is available to you to use as collateral immediately upon taking possession of the property. Naturally, it is assumed that longer-term residents have built up more equity, but there are no minimum ownership duration requirements attached to getting a HELOC. So, if you made a sizable down payment, you can immediately begin drawing upon the equity it provides.
Misconception #8: 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 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, vehicles mostly lose value while homes mostly gain it. You don’t want to finance a depreciating commodity with an appreciating one.