Recently a friend of mine asked me a really good question.
"What is a HELOC?"
She had heard that she made be able to use one to fund her upcoming basement renovation, but wasn't exactly sure what it was, how to access it, or if it was the best option for her family. As with any good question, if one person has it, so does another. So today we will take an in depth look at this tool inside the homeowner's tool belt.
Simply put, HELOC is an abbreviation for: home equity line of credit.
Let's start by breaking down that phrase by defining some simple terms.
Home Equity
According to Investopedia.com, equity is defined as: "the value that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company's debts were paid off." They also define the phrase home equity as "the value of a homeowner's property (net of debt)."
Another way to state this is that home equity is the profit made by a homeowner when you subtract the amount owed on the house (debt), from the amount the home's current value or price home sold for during a transaction.
Home Value - Debt (Amount owed on the house) = Home Equity
Equity is a wonderful thing for a homeowner because it tends to grow over time as we pay down our mortgages and increases anytime there is an increase in home prices and values. This equity is what allows a homeowner to build wealth over time.
It can also become a wonderful tool that homeowner can use to secure a home equity loan or a home equity line of credit. The funds you receive from these loans can then be used for renovations (like my friend's basement renovation), large purchases or debt repayment.
How does it work?
Much like your original mortgage loan application, you will fill out an application with a lender and they will use factors like your credit history, employment, and income to determine your interest rate and the amount you will be able to borrow.
Because these types of loan use the amount of equity you have in your home as collateral for the loan, they often have competitive interest rates, which in turn, makes them a fantastic tool to finance a home renovation or large purchase as opposed to other methods like credit cards which have high interest rates attached.
The downside is that these loans also come with your lender placing a second lien on your home (your mortgage the first lien), which gives them more rights to your home if you fail to make your payments in a timely manner and also lowers the amount of equity you have on your home in general.
Home Equity Loan vs. Home Equity Line of Credit
With home equity loans, you will receive a one time, lump sum of cash, which is great if you need the money for a one time expense such as a renovation, wedding, or other large purchase.
Home Equity Lines of Credit (HELOC) on the other hand are lines of credit similar to a credit card in which you can access the funds as you see fit. You may literally have a credit card to access the funds or be able to write checks or do online transfers. A HELOC makes a lot of sense in situations where you will need to access your funds at different times throughout your project instead of all at once.
Regardless of which type of home equity loan product you want to get, make sure you ask your lender about all the differences when it comes to closing costs, repayment policies, tax implications and benefits, fees, and repercussions if you are unable to make a payment. Knowing all of these details will help you make the best choice for your unique situation.
Have more questions? Reach out and we will do our best to get you connected to a lender who can help!
