Homeowners who need a large amount of cash for renovations, medical bills, their children’s education or other big expenses often choose to borrow a home equity line of credit, or HELOC.
Like any loan that uses your home as collateral, a HELOC is not to be regarded lightly. Failure to repay according to the loan terms will damage your credit score and result in you losing your home through foreclosure.
Use Bankrate’s calculator to help you decide whether a HELOC is right for you.
The pros of a HELOC
A HELOC is fairly easy to get if you have enough equity in your home and a decent credit history.
It is similar to a credit card in that you pay interest only on the amount you withdraw from your credit line. But the interest rate on a HELOC is far lower than it is on a credit card.
In Bankrate’s latest weekly rates survey on May 30, the average interest rate on a $30,000 HELOC was 5.83 percent, while variable-rate credit cards were averaging 17.00 percent.
A HELOC is als0 typically less expensive than a personal loan.
The cons of a HELOC
A home equity line of credit does have some disadvantages. For one, the interest rate is variable so monthly payments can be unpredictable, especially when rates are rising as they now are.
HELOC rates currently are slightly higher than interest rates on conventional mortgages, which is unfortunate for homeowners with a super-low-rate first mortgage who would like to tap their equity. Bankrate’s May 30 survey showed the average 30-year fixed-rate mortgage rate to be only 4.64 percent.
Many lenders also charge an annual fee to keep the HELOC open, even if you don’t withdraw any of the money.
A new wrinkle in the home equity landscape is the new federal tax law, which limits the deductibility of the interest you pay on a HELOC. The law eliminates the interest deduction for equity loans unless the money is spent on improvements that will raise the property value.
An even bigger drawback of a HELOC is that if your home value falls, you could end up owing more than your home is worth. This situation, known as being “upside down” or “underwater,” means you won’t be able to refinance your mortgage and selling your home will be difficult.