Home equity lines of credit, also referred to as HELC, allow homeowners and small business owners to access to cash during a temporary shortfall or an unexpected emergency. Equity lines of credit are one way to obtain a secure, low-interest revolving line of credit. However, before applying for a line of credit, you must understand how this type of credit lines work. It's also important to understand the dvantages and disadvantages of home equity lines of credit.
Advantages of Home Equity Lines of Credit
- Home equity lines of credit work similarly to a credit card account in the sense that your monthly payment is based on what you use. For example, if you’re approved for a revolving account but don’t use it, you don’t owe anything. If you access cash from your account to pay for car repairs three months or longer after being approved, you’ll receive a bill the following month. The bill generally reflects the full mount owed on the account, as well as the minimum payment due. You can pay off the full amount or make the minimum payment only.
- There are no restrictions on home equity lines of credit. You can use the available funds to pay off debt, take a vacation or remodel your home.
- Home equity lines of credit can provide peace of mind. For example, a homeowner who has access to a revolving line of credit can feel at ease knowing that if an unexpected emergency arises, he’ll have access to the needed cash.
Disadvantages of Home Equity Lines of Credit
- Homeowners with home equity lines of credit need to exercise caution. If you have access to an equity line of credit, remember that your home serves as collateral for the debt. If you use the funds to pay off debt and are not able to make the minimum monthly payment, you could lose your home. For example, because home equity lines of credit are low- interest loans, consumers often pay off credit card debt with funds from their equity line of credit. However, if you continue to use your credit card after paying it off, your debt could become unmanageable. You would also increase the your homeownership risk.
- Home equity lines of credit are not 100 percent deductible. Rather, the deduction is generally a portion, or percentage, of your taxes. You may qualify for itemized deductions as long as you don’t have a high adjusted gross income (AGI). To determine your AGI, deduct all your qualified deductions from all your qualified income. The lower your AGI, the more tax benefits you receive. It’s a good idea to consult your tax preparer to determine the effect of a HELC on your finances.
- Some lenders might charge a transaction fee each time you draw funds from the credit line. Others charge a membership fee.
- Opening a home equity line of credit involves costs, similar to securing a mortgage. For example, you’ll need to pay for a property appraisal and an application fee. Moreover, applicants generally pay an up-front fee in the way of points. One point is equal to 1 percent of the credit limit. Other expenses include closings costs, title search, mortgage processing and filing, property and title insurance and taxes.
- Restrictions associated with home equity lines of credit vary according to lender. For example, some lenders set a fixed period of about 10 years on home equity lines of credit. This means that you can only borrow money during the fixed period. Depending on the contract, the owed balance may become due at the end of the fixed period.
When to Use Home Equity Lines of Credit
- A home-improvement project, which can increase the home’s value, is a smart way to use a home equity line of credit, particularly if you‘re planning to sell your home in the near future.
- Use cash from your home equity line of credit only if you’re sure that you can pay off the borrowed amount in a short period of time and only for genuine emergencies.
- Some senior citizens often open a home equity line of credit prior to retiring while they’re still employed and can show proof of income.
Overall, when used wisely, home equity lines of credit can work to the homeowners’ advantage. If you have access to an equity line of credit, keep in mind that your home backs up any money you borrow. Borrow only what you can afford to repay within a short period of time. Preferably, use funds from a home equity line of credit for genuine emergency situations only.
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