If you’re a homeowner, you may have heard of a home equity line of credit, or HELOC. But what is it and how does it work?
A HELOC is a type of 2nd mortgage that lets you borrow money using the equity in your home as collateral. Equity is the difference between the value of your home and the amount you owe on your mortgage.
Unlike a traditional first mortgage, a HELOC is a revolving form of credit, meaning you can borrow and repay money as you need it, up to a certain limit. You only pay interest on the amount you use, not the entire credit line.
A HELOC typically has two phases: a draw period and a repayment period. During the draw period, which usually lasts 10 years, you can access your funds and make interest-only payments. During the repayment period, which usually lasts 20 years, you can no longer borrow money and must pay back the principal and interest.
The interest rate on a HELOC is variable, meaning it can change over time based on market conditions and an index rate, such as the prime rate. Some lenders may offer a fixed-rate option for a portion of your balance.
A HELOC can be a useful way to finance large expenses, such as home improvements, debt consolidation or education costs. However, it also comes with some risks. You’re putting your home at stake if you can’t repay the loan. You may also face fees, such as closing costs, annual fees or prepayment penalties. And your interest rate may increase over time, making your payments more expensive.
To qualify for a HELOC, you need to have enough equity in your home, a good credit score, a low debt-to-income ratio and a stable income. Different lenders have different criteria and terms, so it’s important to shop around and compare offers before you apply.
A HELOC can be a valuable tool for homeowners who need access to cash and have built up equity in their home. But it’s not for everyone. Make sure you understand how it works, what it costs and how it affects your financial situation before you sign up.