HELOC Pros and Cons: Is Getting A HELOC A Good Idea?
A Home Equity Line of Credit (HELOC) can be a powerful tool for paying for large expenses, including home improvements, college expenses, medical bills, and more!
Get Started on Your Home Equity Line of Credit (HELOC)
However, there are some disadvantages of a home equity line of credit. A HEOC is a “secured loan,” meaning that lenders require the borrower put up security or collateral (in this case the borrower’s home) to secure the loan. Because your home is used as collateral, if you default on the loan, the lender can take possession of your home.
At Credit Union of Southern California (CU SoCal), we make getting a Home Equity Line of Credit (HELOC) easier.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all of your banking needs.
Read on to learn more about the pros and cons of home equity lines of credit.
What is A HELOC?
A Home Equity Line of Credit (HELOC) is a type of “revolving” credit that is provided by a lender, has a credit limit, a variable interest rate, and is secured by the equity in a home.
Credit cards are another type of revolving credit, but they come with high interest rates that can make them costly when large amounts of money are needed.
A HELOC typically has a lower interest rate than credit cards and can be used for any type of purchase. Some common uses for a HELOC include home renovations, buying a second home or investment rental property, paying for college tuition, and paying-off high interest debt.
A HEOC is a “secured loan,” meaning that lenders require that the borrower put up security or collateral (in this case the borrower’s home) to secure the loan. Because your home is used as collateral, if you default on the loan, the lender can take possession of your home. This is one of the cons of HELOC loans.
To learn more read, “What is a HELOC?”
HELOC Refinance Eligibility Requirements
Home equity lines of credit are offered by credit unions, banks, mortgage companies, and online lenders. Here are some typical eligibility requirements:
Equity In Home. Equity is the amount of the home you own. A homeowner who doesn’t have a mortgage loan has 100% equity in their home. If you have a mortgage you can calculate your equity by subtracting the mortgage amount from the appraised or market value amount. For example: Appraised value $600,000 – Amount owed on mortgage $250,000 = $350,000 Equity. Divide the equity ($350,000) by the home value ($600,000), which is 58% equity. Most lenders require 15-20% equity for a HELOC.
Home Value. Some lenders will require you to get a new appraisal on your home to determine the home’s value. The lender will use the appraised value in calculating Loan-to-Value (LTV).
Loan-to-Value (LTV). LTV in a HELOC application refers to a comparison of your mortgage loan balance and the current appraised value of your home. Some lenders will get this ratio based on Combined Loan-to-Value (CLTV) by combining the amount owed on the mortgage and the desired HELOC amount to come up with the borrower’s total debt. Credit unions and banks will generally lend up to 85% LTV.
Debt-To-Income (DTI) Ratio. DTI is your total monthly expenses divided by your total monthly income before taxes. Lenders want to know if you’ll have the funds to repay the HELOC.
Credit History. FICO®
uses information in your credit reports and your credit history to generate your credit score. Changes in your report information or score can affect the loan amount and rate you are offered by a lender.
See our article "HELOC Requirements
One reason HELOCs are so popular is that the money can be used in any way with no restrictions. This is one of the main advantages of HELOC loans.
Here are some additional advantages of HELOC loans:
Home Improvements: Having money available through your home’s equity can help you increase the value of your home by using the funds to make improvements such as updating a kitchen and bathroom, installing new windows, and more.
College Expenses: You can use your HELOC to get the degree you always wanted.
Debt Consolidation: Credit card debt can cost you thousands of dollars each year in interest payments. Using your HELOC funds to pay off credit cards can be a smart move.
Emergency Expenses: Having access to quick cash can come in handy if or when the unexpected happens, such as a medical emergency, auto breakdown, a loved one’s funeral, or damage to your home that insurance may not cover.
Investments: Some people use a HELOC to put money down on an investment property or second home.
Wedding: Wedding expenses can really add up, and having extra cash on-hand can pay for the big expenses and all those little extras that help make the occasion special.
Business Expenses: Business owners can use a HELOC to pay for new equipment and supplies, and other expenses that come up.
Pay For A Vacation: While it’s tempting to use a HELOC to pay for a vacation, this isn’t the best use of the funds. Because you’ll pay interest on any amount you spend, that vacation may end up costing you more in the long run. If possible, it’s better to save up for a vacation than use a loan to fund it.
To learn more about how to use a HELOC, read “What Can You Use A HELOC For?
Advantages Of Getting A HELOC
There are many advantages of HELOC loans, including the following:
Only Pay For What You Spend: With a HELCO you only pay interest on the amount you spend. (A home equity loan charges interest on the full amount of the loan, whether you use it or not.)
No Closing Costs: HELOCs don’t require a closing, so there are no closing costs.
No Fees For Cash Draws: There are no fees for using your line of credit.
Low Interest Rates: All HELOCs start with a low variable interest rate that typically stays in effect for 10 years, which is called the draw period.
Convert To A Fixed-Rate Loan: When the 10-year draw period is reach, a HELOC can be converted to a fixed rate loan. Some lenders will let you convert to a fixed rate before the end of the draw period.
Tax Advantages: According to the IRS
, interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. The loan must be secured by the tax-payer’s main home or second home (qualified residence), and meet other requirements.
Flexible Spending: Use only the amount you need, just like a credit card.
Higher Credit Limit Than Credit Cards: The credit limit amount a borrower can receive through a HELOC is largely determined by the amount of equity the borrower has in their home, credit score, and other factors. However, qualified borrowers with ample equity may be able to get approved for amounts up to $1,000,000.
Disadvantages Of Getting A HELOC
Here are some disadvantages of a home equity line of credit:
Interest Rates May Rise: All HELOCs start with a variable rate and quite often it is a promotional rate that changes to a higher variable rate after the promotion ends. After the HELOC draw period (usually 10 years) a HELOC will adjust to a fixed rate.
Using Funds For Frivolous Spending: Having easy access to money makes it tempting to overspend or spend the money on luxury purchases that aren’t necessary. Overspending on a HELOC can result in high monthly payments when the rate goes up.
Only Making The Minimal Payment: Making the minimum monthly payments leaves you paying interest on the full amount owed. To save money on interest payments, it’s recommended you repay the full balance or as much as you can each month.
Hidden Fees: Some Lenders, particularly banks, may charge a pre-payment penalty, annual fee or inactivity fee if you don’t use the loan. Be sure to ask about account fees before you sign for the loan.
Home Value Drops: If the value of your home decreases, that means you’ve lost equity and could owe more than your home is worth. Having a HELOC could increase your debt-to-income ratio, making it more difficult to be approved for other loans or credit.
Set Withdrawal Period: All HELOCs come with a draw period, typically 10 years. This is the amount of time you’ll be allowed to draw from the loan amount. After that, you’ll need to repay the principal amount of the loan.
You Can Damage Your Credit: If you fail to repay the loan, make late payments or are unable to make your mortgage payments, these events will be reported to the credit bureaus and your credit score will go down.
Loan Collateral: Because a HELOC is secured by the equity in your home (i.e., uses your home as collateral), defaulting can result in the lender foreclosing on your home.
HELOC vs. Home Equity Loan vs. Cash-Out Refinance
HELOC: The most distinguishing characteristic of a HELOC is that it is a line of credit. A line of credit allows you to draw from it any amount you need. You’ll pay interest only on the amount you borrow, not on the full credit line. Interest is paid at a variable rate during a draw period of typically 10 years. After that, the interest rate may adjust to a fixed rate and monthly payments will then include both principal and interest on the outstanding balance.
Home Equity Loan: A home equity loan differs from a HELOC in how the funds are disbursed and the interest rate. A home equity loan provides funds in a lump sum and the interest rate is fixed. Like a HELOC, the amount of the loan given by a lender is based on the borrower’s home equity, LVT, DTI, and credit score. Often referred to as a “second mortgage,” a home equity loan is a big financial responsibility. Monthly loan payments will include both principal and interest, whether you actually use the funds or not.
Cash-Out Refinance: With mortgage interest rates very low, refinancing your current mortgage to a new mortgage at a lower interest rate could help you lower your monthly payments. Getting cash-out on a refinanced mortgage means borrowing more than what you owe on your current mortgage, paying off that loan, and getting a cash disbursement of the extra funds at closing. You can use your cash-out any way you choose.
Learn more by reading “HELOC vs. Home Equity Loan
” and “Cash-out Refinance vs. Home Equity Loan
Is Getting A HELOC A Good Idea?
A HELOC can be a great way to access the full value of your home to get the money you need. However, there are pros and cons of getting a HELOC.
What are the pros and cons of a HELOC? If you need of money and are trying to decide between using your credit card or a HELOC, the HELOC will likely save you money on interest, even with its variable rate.
Although HELOCs can provide you with a significant amount of money to use as you please, it’s important to be sure you have the financial means to make monthly payments on two loans. After the HELOC draw period ends, principal and interest will be combined into one monthly payment at a fixed interest rate.
When is it a good idea to get a HELOC? For homeowners with at least a 660 credit score, steady income, and the right amount of home equity, a HELOC can be a great option for getting the cash you need.
How To Apply For A HELOC
Applying for a HELOC is really pretty easy. You’ll need to provide the lender with:
Personal Information: This typically includes two forms of government-issued identification.
Employment and Income Information: Lenders will ask for your most recent W2s or 1099s (if you are self-employed), pay stubs and other statements that show you have money coming in and will be able to pay back the loan.
Mortgage Details: Be prepared to show your most recent mortgage statement.
Property Information: This will include the address of the subject property. A property appraisal will likely be required.
Information on Outstanding Debts: The lender will ask for statements for any outstanding loans you may have, including auto loans, student loans, and other debt.
CU SoCal HELOC
CU SoCal offers an interest-only HELOC, so you pay only the interest due each month, giving you the flexibility to keep payments low during the 10-year draw period of your loan. We offer the choice of either a lump-sum loan or a revolving credit line that can be used over and over again.
Advantages of HELOC loans from CU SoCal:
- Access up to 80% of your home's equity.
- No points.
- No appraisal fees for single unit loans.
- No annual fee.
- No closing costs.
- Loan limit up to $250,000.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Apply for a HELOC today!
Get Started on Your Home Equity Line of Credit (HELOC)