Of the many ways there are to tap into the equity that your home has acquired with time and appreciation, one of the most flexible is to set up a Home Equity Line of Credit, or HELOC, as it is commonly known. Unlike a standard home equity loan that is paid to you in a lump sum and paid back in a fixed amount of time, usually at a fixed interest rate, a HELOC establishes a certain level of credit, secured by a lien on your home, against which you may draw as you need it. It can provide you with a comfortable cushion for unexpected expenses like small renovations, extra college bills or medical expenses.
The chief advantage of a HELOC is that you only pay interest on the money you actually use, like a credit card. This gives the borrower far more flexibility than with a standard home loan or second mortgage on which you pay interest on the full amount from the date of origination whether you are actually using the money or not. Also, because a standard home loan generally has a fixed rate of interest for what could be a term of many years, it carries a higher interest rate than a HELOC. Many HELOCs are also structured as interest-only loans during the first few years of their existence, meaning you only pay the interest and no principal initially, making them even more attractive. In both cases, the interest is tax deductible up to a certain amount based on the use for which the money is being borrowed. It’s complicated, so consult a tax professional to determine into which category your HELOC will fall.
The amount you can borrow, of course, depends on how much equity you have in your home, which is why a current property appraisal is part of the application process. The days when you could borrow up to 100%, or even more, of your home’s value are long gone. Most lenders these days limit your total borrowing, including your first mortgage, to a maximum of 80% to 90% of your home’s value.
Financial experts advise that you use a HELOC for short-term and unexpected expenses and pay it back as early as you can so you will still have credit to draw on if other needs arise. For this reason, a HELOC is not the ideal loan for long term projects like major home renovations. The great advantage of the HELOC is that you can have it in reserve for a rainy day, something that is not possible if you spent it all on a new kitchen. Have questions – give me a call, 860-274-7467!
Stephen Yonych, Jr
Watertown Branch Manager, Assistant Vice President
NMLS ID# 701846