What is a Home Equity Line of Credit?

If you have owned a home for a few years and have seen its value rise, you might consider tapping the equity for home improvements, a college education or something else worthwhile. There are two ways to do this. One of them is with a Home Equity Line of Credit (HELOC) and the other is with a fixed equity loan.

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What Is a HELOC?

A HELOC is the biggest way that people borrow their home equity today. It is a type of revolving credit that is similar to a credit card. The difference is that it is secured by your property, allowing you to get a much lower interest rate than with an unsecured credit line.

With your HELOC, your lender gives you a certain credit line that you can use to pull out your equity. It gives you a certain period of time to pull the money out, usually 10 years. During the draw period of 10 years, you make interest only payments on the borrowed funds. At the conclusion of the draw period, you start t pay back the principal on your loan. The repayment period normally is from 10-20 years.

The money you may borrow with a Home Equity Line of Credit is based upon how much equity you have in your property. This means that you can borrow a percentage of the value of the home, reduced by how much you owe on the mortgage. Most lenders restrict you from borrowing more than 80% of the value of the home. HELOC rates are mostly tied to the prime rate and are lower than credit cards, but not as low as your first mortgage.

What Can You Use a HELOC For?

You can use the equity you pull out for whatever you want. You might use it to pay for college education, pay for a trip, or pay off credit card debt.

However, many experts think that the best use of your home equity is to improve your home. If you cannot pay back the loan, you could have your home foreclosed. However, if the money is used for home improvements, you will likely see an increase in the home's value.

Then you can refinance the home if you want and the home's value has increased. You then are more likely to get the loan. A HELOC can be a good choice if you are making home improvements and have regular construction expenses. However, there are other good uses for a HELOC. Some people like to just have a HELOC available in case of a financial emergency. If you have the HELOC set up and the credit line is open, you can draw out the cash immediately. If you wait to do a HELOC until the emergency arises, it can take a few weeks to get the deal done and closed.

Benefits of a HELOC

A major benefit to using home equity to improve your property is that the interest is fully tax deductible, the same as on your first mortgage. The limit on that is $1 million, but that covers the vast majority of homeowners.

How to Get a HELOC

You would shop for a Home Equity Line of Credit just as you would for your first mortgage. You can go to a bank, credit union or mortgage broker to get your loan. You do not need to go to your first mortgage lender to get your HELOC; you may be better served by shopping around.

With your HELOC, you can expect to pay some fees and closing costs, but it will be less than your first mortgage; after all, the money being borrowed is much less in most cases. You probably will have to pay for an appraisal; this is how the lender determines how much your home is worth. There may be some loans out there without any fees, but be wary: This almost always means the costs are rolled into the loan, or you are paying a higher interest rate.

The Risks of a HELOC

Taking out another mortgage on your property obligates you to pay back that loan. You should be certain that you will have the cash flow for many years to pay that loan back. Remember that you only are paying interest during the draw period. The draw period will end eventually and your payment will jump. Can you handle that extra expense?

Last, remember during the last downturn, many homeowners took equity out of their homes, their homes tanked in value, and they could not refinance. They were stuck with payments that they could not afford after many people lost their jobs. So, the lesson is: Be careful when you are pulling money out of your primary residence, as it can come back to bite you.

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How a HELOC Loan Can Transform Your House Before You List It on the Market

As you are thinking about listing your home and selling, you may want to consider doing some renovations. That way, you can transform your home, make it have more curb appeal and possibly increase its value. One of the most popular ways to get the money for those renovations is to get a home equity credit line. This is also referred to as a home equity line of credit or HELOC loan.

With a 2nd mortgage, you can pull that money out and do what you wish with it. There are two basic types of secondary finance options:

  • Home equity loan, which is for 15 or 30 years and has a fixed rate.
  • Home equity line of credit or HELOC loan, which gives you a credit line up to a certain amount that can be used over 10 years, usually. The rate for a HELOC fluctuates.

How a HELOC Works

If you have been making payments on your home for a few or many years, you probably have a chunk of equity in the property. It could be even more if the property has gone up in value. You can take out the line of credit on your home up to the amount of equity that you have. That line of credit can be used as you like to do home improvements. One of the advantages of a line of credit on your home is that you only need to take out the money as you use it. So, you only pay interest on the money that you take out. This can be a perfect way to get money for home improvements.

A big advantage of using your home equity to do home improvements is that the interest you pay on the new loan is tax deductible and low interest. If you max out your credit cards, you cannot deduct the interest, and it is a much higher rate than a home loan. If you do decide to take out a home equity credit line before you sell, you should consider these improvements to add value:

#1 Replace Siding

Replacing old siding with new vinyl may not be the home improvement you think about first, but it is one that will pay you back when you sell. Experts say new siding on a typical home will cost $10,000 or so, but you will get more than 80% of that back when you sell. Keep in mind as with many home improvements that are obvious, it will catch the buyer's attention and may get you more offers faster.

#2 Replace Garage Door

For homes that face the street, the garage door is very obvious. Replacing the garage door can really transform the front of the home, and statistics show that it ranks as one of the highest ROI home improvements. The average new garage door costs about $2000, and you will see an 87% return on investment.

#3 Wood Floors

Installing good quality wood floors will get you back much of the cost when you sell. The average cost is $5000, and you will get back about 90% of that at closing. Experts say that homes will sell better when floors are made of wood. Oak is especially popular on the East Coast.

#4 Insulation

This home upgrade is not obvious and not sexy, but adding more insulation only costs about $2000 and you will get almost all of it back when you sell. Energy efficiency is more important today, and homeowners want to know if they are going to be able to reduce their heating and cooling costs in the house. Another nice aspect of adding insulation is that it is easy to do and you can do it yourself easily on a Saturday.

#5 Refinish Floors

If your home has hardwood floors, you really should consider refinishing them. This costs about $2500 in the average sized home and you will get almost all of that money back when you sell. Attractive hardwood floors attract potential buyers and will get you higher offers, experts say.

#6 New Roof

If you want to get a maximum return on your home improvement dollar, you cannot beat a new roof. A new roof can cost up to $10,000, but you will recoup on average all of what you spend, and possibly more, at closing. It is one of the few renovations that will return more than its cost. However, note that most buyers are not going to buy a home because it has a new roof. If the roof is new and they think they want the house that could be the thing that pushes them over the line and gets them to make an offer.

Getting a home equity credit line can be a great move to improve your home before you sell. You should consider the above home improvements and you should be able to attract more buyers and better offers. Just be certain that you do not overspend on your home improvements. You want the quality to be there, but if you get premium materials for everything, you may not see all of that money come back to you when you sell.

1. Low Payment HELOCs
2. Opportunities to Receive Cash
3. Credit Line Amounts from $10K to $1 Million

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