When is a line of credit on your mortgage the best choice?
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If you want a line of credit to cover home renovations, a new car, your child’s college education or even debt consolidation, a home equity line of credit, or HELOC, may be a great option.
"A home equity line of credit, or HELOC, is a mortgage loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the borrower's equity in their house," explained First Bank CEO Patrick Ryan. "It is a line of credit secured by the borrower’s home that gives them a revolving credit line."
How does the revolving credit line work?
With a traditional HELOC, as the outstanding balance is repaid, the amount of available credit is replenished – much like a credit card, said Ryan.
"This means you can draw (advance) against the line again if needed throughout the draw period up to the approved credit limit," he said.
In general, lenders offer a number of different ways to access those funds, whether it’s through an online transfer or writing a check.
"At the end of the draw period, the repayment period begins whereby the line is no longer available for draws/advances and will need to pay back any money owed," Ryan continued.
When is it beneficial to take a line of credit, why, and what are the advantages?
HELOCs can be used for renovations, large purchases, debt consolidation of higher interest credit cards and loans and college tuition.
"Rates are usually competitive, very low, and variable tied to an index like the Prime Rate," Ryan noted.
Usually, he said, HELOC rates will match the index rate with no margin added or some lenders will add a margin of 0.25% to 1% to the index.
"Compared with unsecured borrowing sources, such as credit cards, borrowers will be paying less in finance charges for the same loan amount," Ryan said.
Borrowers will need to qualify for a HELOC, and lenders underwrite HELOCs much like other home loans, he noted.
"They have guidelines that dictate how much they can lend based on the value of the property, equity available, and the borrower’s creditworthiness," Ryan explained.
Is it better than using a credit card?
According to Ryan, generally, HELOC rates are much more favorable than credit card rates because credit card rates can be as high as 24%. With a HELOC, he said, borrowers will be paying less in finance charges for the same loan amount. Also, there may be tax benefits with a HELOC, as the interest may be tax deductible. Be sure to consult a tax adviser to be sure.
"When someone takes out a personal loan or borrows from a credit card, for example, not only will they pay a higher interest rate, but they cannot claim a deduction on their taxes," Ryan said.
Even though interest rates are likely more favorable by having a HELOC, your home’s equity will be affected.
"A HELOC is a tappable account that you can access against the equity in your home and this can work like a checking account where you write checks or wire funds from a HELOC," said Nicole Rueth, senior vice president at Fairway Independent Mortgage Corporation. "As you spend this money it reduces the amount of equity in your home. These funds will be required to be paid back either as a mortgage payment for if you refinance or sell your home."
But, you can continue to borrow if you need. Rueth said that once a HELOC has been opened it has a 10-year draw period allowing the homeowner access to the funds without having to qualify again.
"This can give someone peace of mind when needing cash in an emergency," she said.
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