Using your home to secure a second loan can have huge benefits if you do it right.
What is a HELOC?
A home equity line of credit, also known as a HELOC, is a financial product that permits a homeowner to borrow against the equity in his or her homes.
As you make your monthly mortgage payments, the balance of your mortgage decreases over time. If the value of your home stays the same or increases, this gives you equity in your home. The equity in your home is equal to the value of your home, less any loans against the property.
Home equity products are a popular way for homeowners to tap their equity. The HELOC works like a credit card. You draw against the line of credit only as needed.
Each month, your monthly payment is a percentage of the amount that you own. The interest rate for the HELOC varies each month, but rates are usually affordable, especially for well-qualified borrowers. Your payment also changes each month, depending on the current interest rate and your HELOC balance.
In contrast, a home equity loan is a one-time transaction. You decide how much you want to borrow and take all of the equity out at one time. Your loan has a fixed interest rate, and the payment stays the same every month. However, to take more equity out of your home, you have to apply for a new loan.
Some of the reasons you might use a HELOC are:
- Paying for home renovations.
- Paying for college tuition.
- Consolidating credit card debt into one affordable loan.
Another benefit of the HELOC is that if you itemize your tax deductions, your interest expenses may be tax deductible.
Pam and Mike organ bought a house in September 2009 for $172,000. They made a 20 percent down payment and refinanced 3 years later. In May 2017, they applied for a home equity line of credit.
Here’s how the bank calculates how much they can borrow:
Home’s current appraised value: $190,000.
80% of appraised value: $152,000 ($190,000 x 0.8).
Amount Pam and Mike owe on their mortgage: $128,633.
80% of home’s value minus amount owed: $23,367.
The bank will give them a credit line of $23,367 or less.
Ready to borrow against your home? See what product is best for your financial needs.