What is a HELOC and How Does it Work?
May 2019
There are many reasons to borrow money, from renovating your home to paying for college or paying for your daughter's wedding. While credit cards carry higher interest rates and may work for smaller, more immediate purchases, there are other methods of borrowing money that go beyond credit cards and personal loans, such as a Home Equity Line of Credit (HELOC).
Applying for a HELOC is similar to applying for a mortgage, but there are some vast differences in both structure and repayment. Both a home equity loan and a HELOC use your home as collateral against the borrowed money.
Unlike a standard loan, however, a HELOC provides a level of flexibility in borrowing and spending that is comparable to a credit card. While the amount you can borrow is dependent on your home equity, your credit score, and other aspects of your personal financial situation, how you spend the borrowed money is entirely up to you.
Banks and other lenders, such as credit unions, can offer HELOCs that are up to 80 percent of the equity of your home. The flexibility of a line of credit is exhibited in how the borrower uses the money. If you receive a line of credit for up to $100,000, you can choose, for example, to only use $30,000 of that amount. In turn, you will only have to pay back the principal and interest on the amount used, not on the entire borrowing limit.
On the other hand, home equity loans are borrowed and dispersed in one lump sum. These loans are often for large renovation projects and have set repayment terms and interest rates. Once borrowed, you begin repayment immediately.
The HELOC is also unique in that it enters a draw period — sometimes up to 10 years — in which you can draw on the line of credit in amounts as small or as large as you need. Most lenders even offer checks or account cards so using your line of credit is convenient and easy. During the draw period, you make payments on the interest of the amount borrowed.
Where loans often have set interest rates, the HELOC often has a flexible rate and will adjust according to certain indicators and indexes used by the lender. The variable rate may seem risky, but on average it remains much lower than a fixed rate.
When dealing with large sums of money, a few percent savings in interest payments can go a long way. After the draw period ends, the HELOC enters a repayment period that can be a few years to a few decades in length.
The HELOC provides an advantage to other loan types and home equity loans. It offers flexibility and convenience that other loans don't provide, making it possible for you to fund your home renovations while also paying off your high-interest credit card or that unexpected medical expense.
As with any type of borrowing or credit, comparing rates and lenders is the first step to determining which lender and which loan type are right for you. Many home equity lines of credit come with fees for opening, closing, or drawing funds from the account. Be sure to ask lenders what all of the applicable fees will be, what interest rates are available within your financial situation, and how the HELOC can most benefit you.
About Best Financial Credit Union
Unlike being just another bank customer, at Best Financial Credit Union, you're a member. We offer competitively low rates for a home purchase or refinance on primary residences, second homes, vacation homes, and investment properties. We have a wide range of financing options available, budget-friendly and accommodating repayment terms, and a team of helpful loan advisors with working knowledge of the local real estate market in West Michigan.
