HELOC Pros And Cons

Home equity loans (HELOCs) are home loans that let you take cash from your home when needed. The HELOC is similar to a credit card in that it has a maximum balance. You can then draw on the balance and repay it over a time period of typically 10 or 20 years.

Let's look at the pros and cons of a HELOC to help you decide if it's right for you.

The Top Reasons You Should Use A HELOC

A HELOC Is A Loan That You Pay For As You Use It: 

It's not a cash withdrawal from your home. It's set up to have a maximum drawable amount. If you kept the balance at zero, your monthly payment would be zero. A HELOC is a flexible tool that allows you to have cash only when you need it. Once you use the HELOC, you will receive a monthly statement. The payment will be based on the remaining balance.

You Can Make Interest-Only Payments To HELOCs: 

For example, a HELOC with a balance of $35,000 will have an interest-only payment that is $85 per month less than a 20 year fully amortized payment. This is a common amortization period for HELOCs that are fully amortized. This is a good way to save monthly cash. However, your lender may qualify you by making a fully amortized payment of the HELOC's maximum amount or using a more stringent qualification formula. This is the worst-case qualification method to prevent you from getting a loan that you can't afford. In addition, your HELOC may have an interest-only option that you pay. If you do not choose to pay this option, your balance will not be paid down. Make sure to locate a HELOC lender who will guide you through both options prior to securing a HELOC.

Investing To Buy A New House:

The HELOC allows you to use the equity in your home to purchase or make a down payment for a home. It can take several months to buy a home. If you took out a traditional cash-out loan for funds, you might be paying interest on those funds for years after you have invested them. You only pay the HELOC interest when it is used. This allows you to leave the HELOC at zero balance while searching for homes. The HELOC funds will then be available to you when you are ready to purchase a home.

Home Improvement:

You wouldn't want all the funds to be used if you were slowly remodeling your home. Imagine that you wanted to remodel your kitchen for $25,000 and then wait one year before renovating your bathrooms for $25,000. A traditional home loan, such as a cash-out refinance mortgage, would allow you to start paying interest and payments on $50,000 from day one. A HELOC would allow you to use $25,000 for your kitchen and add $25,000 to the balance. This payment wouldn't be added until one year later. This would allow you to save about $100 per month on interest over the course of that year.

Large Purchases Like A Car Or Large Appliances:

You should compare HELOC costs and financing costs if you are looking to finance large purchases like these. A HELOC is often a good option for large purchases like these.

"Fixed-Rate Advance" aka "Fixed-Rate Draw" Option:

HELOCs can be fixed-rate loans or adjustable-rate loans. You could fix that portion of your HELOC draw if you were to remodel or purchase a car or other appliance. You could also use a fixed-rate advance option for that HELOC draw. If you are certain that you won't be able to repay the amount for a longer time, this is an option.

Top Reasons To Not Use A HELOC

Rates Can Be Adjusted:

HELOCs can be adjustable-rate loans. HELOC rates have two components. A fixed base rate is called a "margin," and a fluctuating rate is called an "index." The Prime Rate indexes HELOCs. This is a rate that fluctuates as the Fed adjusts rates each year. The Prime Rate has averaged 5.39% over the last 20 years. It peaked at 9.5% in the 1990s. A common margin is 1%. The average HELOC rate over the last 20 years has been 6.39%. Although this rate is comparable to fixed-rate cash-out loan options, it's still competitive. This is because we have largely been in a low-rate environment for the past twenty years. The Prime Rate and HELOC rates will rise if the economy improves. You might be better off getting a fixed-rate loan now than you are in the future. Ask your HELOC lender for information on cash-out loans.

The payments can be more. Many HELOCs require that you pay an amortized payment. This amortization period is usually 20 years. This HELOC payment will be significantly higher than the traditional cash-out refinance of your first mortgage. It would normally amortize over 30 years. You shouldn't assume that a HELOC payment will be lower. Compare all options.

Not Always The Best Option For Buying A Home:

HELOCs are a good option for cash-flow short term, especially if it's going to be paid off quickly. If you are using the HELOC to purchase a home, which is possible by making it a second mortgage, and don't plan to pay it off immediately, you might want to consider a fixed-rate second mortgage. A HELOC, which is an adjustable-rate loan with variable interest rates, can be safer than a fixed-rate loan if the loan is held for a longer period.

A HELOC Does Not Function As An ATM:

Instead, a HELOC acts much like a credit card, in that you can draw on it whenever you need it. This makes it tempting to use it for everything you want, such as groceries, clothes, and vacations. However, this can deplete your home equity, and you should not use your home equity to purchase short-term items if your home is a long-term investment.