Potential Benefits And Limitations of HELOCs
A home equity line of credit (HELOC) is a type of loan which allows you to tap into the built-up equity in your home. You can use it for a variety of different purposes – consolidating high-interest loans, paying your children’s college tuition, renovating your home, and so on.
How Does a HELOC Work?
A HELOC typically consists of two phases – the draw phase and the repayment phase.
During the draw phase, you can borrow as much money as you need (in proportion to the amount of equity you have built up in your home) on an as-and-when needed basis. During this phase, you have to pay interest on the amount of money you draw.
During the repayment phase, you need to repay the principal as well as the interest.
What are the Upsides of a HELOC?
- You can borrow as much money as you need over a period of time, which makes it easier to pay for recurring expenses.
- During the draw phase, you only need to pay interest on the money you borrow, not the total amount of credit available to you.
- The rate of interest tends to be much lower compared to a personal loan or a credit card.
- Interest payments on a HELOC are tax-deductible to a certain limit if you use the principal to renovate or rebuild your home.
- Many lenders allow you to convert your HELOC into a fixed-rate loan, which can protect you against rising interest rates and increasing monthly payments.
What are the Downsides of a HELOC?
- The interest rate on a HELOC is variable, which means your monthly payments might increase from time to time.
- The interest-only payments during the draw phase might tempt you to borrow more than what you can afford to repay.
A HELOC could be an effective way to monetize your home equity. You need to, however, proceed with caution and borrow only what you need so that you do not end up owing more than what your home is worth.