Is A HELOC Right For You?
July 1, 2020
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Erica is a homeowner. She and her family have lived in that home for years and absolutely love it. It is convenient to the gym and their favorite grocery store. It has a nice yard for the dog. The home really is perfect, except for one thing…. the kitchen. It has linoleum floors and a wallpaper backsplash stained with mystery sauce. To say the least, it is nothing like the sparkling new kitchen of Erica’s dreams. But Erica also knows that remodeling a kitchen is expensive and she is not quite sure where she would get the resources to create that dream kitchen…
Maybe you are like Erica, but instead of a dream kitchen, It’s a new screened-in back porch or an updated master bathroom. And if you are a homeowner who has paid down a significant portion of your mortgage, you may be sitting on a mountain of untapped equity that can be used to finance home improvement projects like these.
Home Equity Lines of Credit (HELOC) is a line of credit secured by your home that gives you a revolving line of credit to use for unexpected expenses. HELOCs are a great way to make the most of the equity in your home. Below we will discuss the best uses and benefits of a HELOC, qualifications required, and general terms of the HELOC.
A HELOC is similar to a credit card in several ways with one very important difference. The debt is secured by your home. Like a credit card, a HELOC provides a revolving line of credit that you pay down and then borrow again. Also, as with a credit card, you only pay interest on the funds used. A HELOC generally provides a lower interest rate than a credit card, which makes it a great option if you know you can manage the payments. Because you only pay interest on the funds used, a HELOC is a smart choice when you are unsure how much money you will need for the expense. Below are the best uses of a HELOC.
- Home Improvement Projects
- Under recent tax law, interest on a HELOC used to “buy, build, or substantially improve” a home may be tax-deductible. For details, be sure to consult your tax advisor for details about deductible interest.
- With home improvement projects, you can’t always be sure exactly how much money you will need to complete the project. A HELOC allows you to only draw funds as needed.
- Emergency Expenses
- Unexpected home repairs
- Medical bills
- Education Fees
- If you are not able to secure federal loans, a HELOC could offer better interest rates than private loans. Just remember, while student loans are unsecured debt, a HELOC is secured by the value of your home. So be sure you are in a stable financial situation before using your home as collateral.
A HELOC requires an application process similar to a mortgage. A lender will look at a credit score, employment history, monthly income, and debt. You will need to have equity in your home. To determine the percentage of equity you have in your home, refer to the formulas below.
Home’s equity = Appraised Value of Home – Mortgage Balance
Home’s equity in dollars / Appraised Value of Home = Equity Percentage
To determine the estimated maximum amount you could borrow, refer to the example below.
Say your home is valued at $200,000.
$200,000 * 85% = $170,000
Then subtract that amount by your remaining mortgage balance.
$170,000 - $120,000 = $50,000
$50,000 would be the maximum HELOC amount available to you. However, note that depending on credit score, debt to income ratio, and other information you may qualify for less.
HELOCs can be a smart financial resource when used correctly. They combine the benefits of revolving credit with lower interest rates usually, and in some cases, the interest is tax-deductible. Just remember, with a HELOC, you are using your home as collateral. This means your home could be at risk if value drops or there is an interruption in income.