A HELOC, or a home equity line of credit, is set up to have a maximum draw limit rather than just a set dollar amount in the form of a lump sum like a home equity loan. Similar to a home equity loan, a home equity line uses your home as security.
This line of credit is set up to a certain amount decided between you and your lender (generally 80% of the market value on the home in question minus any fees currently owed upon it) that can be drawn out in a set amount of time. A HELOC, in simple terms, is a recommended alternative to a home equity loan for those with ongoing projects.
So, you are in desperate need of cash, got projects to fund, mouths to feed, bills to pay, and so you decide to drop by the bank and get a loan. First option you are presented with when offering your home as collateral is whether to go with a home equity loan or a HELOC, or simply a home equity line.
In most cases a HELOC will probably be your better choice, simply because when you need the cash, you have it, and when you don’t, don’t worry about it. Sounds simple enough, and for those in need, a HELOC is a welcome alternative to many other loan choices because you won’t have a lot of money just sitting around that you have to pay interest on.
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The easiest way to describe how a HELOC is a superior loan alternative is safety. With a HELOC you obtain safety in both terms of being more likely to handle your payments as well as safety from yourself. When the money isn’t just dumped into your pocket all at once you are less likely to waste it and end up in trouble.
A HELOC generally has low settlement cost rates (on a $150,000 line of credit it would be around $1000 compared to $2500-5000 for a home equity loan of the same amount). While other fees associated with a HELOC tend to be more expensive, overall a HELOC doesn’t cost that much more that a standard home equity loan.
In addition, the idea of saving you from, well, you, plays an important role as well. If you just receive all the money up front and it’s just sitting there, you are going to be tempted to spend it on things you don’t need. Obviously this situation can come back to hurt you.
However, in a HELOC, since the money isn’t just sitting in the bank but is rather drawn out when you need it, you will be less tempted to spend it and you also will not have to pay interest on money you do not use.
Disadvantages of a HELOC
The main disadvantage to a HELOC is that people are likely to try to go for long term repayment. Although the monthly payments can be held in check in long term repayments, what ends up happening is that the item purchased with the loan doesn’t last nearly as long as the repayment schedule.
In essence, you will be paying for something you no longer have. Similar to a home equity loan, a HELOC also puts you in danger of losing your home. If the payments can’t be met then serious problems arise.
A HELOC is also available to people with bad credit, and can even be used to improve credit as long as payments are made on time. Since the security is a home and the line of credit given out is usually less than the value of the home, lenders have little risk offering these types of loans to everybody.
We hope we have shed a little light on the world of home equity for you here. Hopefully after reading this article you will be better prepared on how to handle your money problems.
Just keep in mind that whenever getting a loan with something as valuable as your home as collateral to be careful, be smart, and always take the time to shop around and read the fine print.