If you pick up the Wall Street Journal on any particular day, you might find an article that mentions HELOCs. You probably see that word on a poster or rate board at your local bank as well. You might get something in the mail (or e-mail) from your credit union advertising the best HELOC rates around. That is all great if you know what a HELOC is. Consider this post HELOCs for dummies.
HELOC stands for Home Equity Line of Credit. HELOCs are a form of home equity loan. Since I have never discussed home equity loans before on this site, I figure we can knock out two birds with one stone. So sit back, relax, kick your shoes off, and get ready for a short lesson on real estate loans.
First off, you need to own a home and have equity to qualify for any home equity loan, as the name implies. Home equity is the ownership you have built up in your home. To calculate your equity, subtract your outstanding loan principal from the present value of your home. If your home is appraised to be worth $250,000 and you have $100,000 left on a mortgage, you have equity of $150,000. Equity changes based on those two inputs. If the value of your property goes up or down, as constantly happens due to market conditions, your equity will change. If you pay down your mortgage loan, you will also impact your equity.
So, in the example above you have equity of $150,000. If you need a lot of money for a planned purchase, such as a car or large home improvement, you can take out an installment loan based on that equity. The rate of a home equity loan is generally the lowest interest rate a consumer can find. However, it also means that if you stop paying, the bank can foreclose on your house. If you plan on paying every month (as we all do), you can get a better “car loan” rate if you use a home equity loan instead.
Sometimes, however, emergencies come up. We don’t all have an emergency fund, even though we probably all should. For these scenarios, HELOCs come in handy. A HELOC is a line of credit attached to your property. Like all lines of credit, your HELOC works kind of like a secured credit card with unique fees.
If you decide you want a HELOC, you will have to pay fees up front to create the loan. Once it is established, you never have to use it. If you don’t use it, you don’t have to pay any more. If you do use it, you have to pay interest on the outstanding balance, like a credit card, and pay back the loan balance at a later date. Some HELOCs simply accrue interest and require no payment until the end date of the loan. Some require interest only until the loan end date. Others institute a minimum payment based on the outstanding balance. You can generally negotiate this with the bank when you set up the loan.
If my opinion, HELOCs are a good idea for established homeowners for emergency use. If you are new in real estate, this is just another complicated loan that lets you spend money you will eventually have to pay back. If you have a lot of equity and want to be ready for when the water heater breaks, you need to replace the furnace, or a plumbing emergency comes up, a HELOC might be right for you. Just remember, it can take weeks to setup this type of loan. If you want it in an emergency, waiting for the pipe to break will be too late.
If you think I missed anything or have any questions, feel free to say so in the comments.