If you own a home and have equity in it, you can borrow against this equity over time, similar to the way you use a credit card. Called a home equity line of credit, or a HELOC (pronounced “hee-lock”), a mortgage line of credit differs from a home equity loan, which allows you to borrow a lump sum of money. A HELOC can be a valuable tool for you to use, once you understand the ins and outs.
About the HELOC
Typically, the interest rate you pay on a HELOC is less than what you pay on your credit cards. Most HELOCs offer a variable rate based on a public index, such as the prime rate. Check with your mortgage lender as well as other lenders to find the lowest rate. In most cases, you can deduct the interest you pay on your HELOC on your income tax. Know the terms of your HELOC, though, because you're putting your home on the line when you open and use one. You get a credit card and/or checks to access your line, but if you borrow money and cannot make your monthly payments, you can lose your home. Also, if you want to sell your home, you'll probably have to pay the HELOC back at that time.
Getting a HELOC
Lenders calculate how much money you can borrow on a HELOC based on your income, your credit score and your debt. You may be able to borrow up to 85 percent of the worth of your home, less what you owe, but be prepared to pay costs similar to when you bought the home. You typically pay an appraisal fee to determine the value of your home, an application fee, an up-front charge called points -- one point being equal to 1 percent of what you borrow -- and closing costs. Expect to pay a few hundred dollars to set up a HELOC.
When to Use
A HELOC can be a good deal for you if you have ongoing expenses, such as long-term home improvement projects or recurring medical bills. When interest rates are low, you typically fare better with a HELOC. However, if rates go up, so will your HELOC. Ask your lender about the HELOC's lifetime cap, to learn what's the most you will pay if interest rates rise.
When Not to Use
Don’t be tempted to use your HELOC on a whim. As appealing as that line of credit may be, you shouldn't use it for frivolous purchases, such as vacations, clothes or electronics. If you need to borrow money from your home to fund those sorts of expenses, you're probably living above your means. If your spending's out of control to that extent, the chance of not being able to make the payments, and losing your home, increases.
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