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HELOCs: What are they, and how do they work?
HELOCs: What are they, and how do they work?
A home equity line of credit (HELOC), is a loan that lets you borrow against the equity in your home. Similar to credit cards, HELOCs allow you to continuously borrow against your line of credit up to a certain amount, instead of taking out a lump sum like you would with other types of loans.
How does it work?
Most HELOCs consist of a draw period and a repayment period. During the draw, or borrowing, period, you can borrow up to a set amount, similar to an open line of credit. You can borrow up to this limit, pay it back, and then borrow again until the draw period ends.
With many HELOCs, only interest is due during this time, although monthly minimum payments may also be required. This period of time varies, but is typically around five to 10 years.
Then, during the repayment period, you’ll pay off the amount you borrowed, plus interest, in monthly installments. Like the draw period, the length of the repayment period varies. Some HELOCs also include various fees, including origination and closing fees.
Advantages and disadvantages
HELOCs allow you to borrow and pay interest on only what you need, which can be helpful when you’re not sure how much you’ll have to take out for a specific endeavor. Additionally, many HELOCs have adjustable interest rates, which means they go up or down according to standard rates. This can be both a pro and a con, depending on the rates at the time. You may get a lower rate than a credit card that has a high APR, but your rates may also fluctuate, depending on the HELOC.
Another major advantage is that you can use the money for almost anything. While many homeowners take out HELOCs for renovations or major repairs, you can use the funds to consolidate debt, pay for education expenses, and more. Plus, if you use the money to make improvements to your home, the interest you pay may be tax deductible.
However, it’s important to remember that this line of credit is not the same as a credit card, and should not be used to fund everyday expenses. When you take out a HELOC, you’re borrowing against the equity in your home, which means you’re using your home as collateral. So, if you don’t repay, you risk foreclosure.
The bottom line
HELOCs can be useful financial tools, but it’s important to understand exactly what you’re signing up for. Rates and fees may vary, so make sure to do your research and talk to your lender before making any big decisions.
Find out more about our home equity line of credit options here.