Home Equity Lines of Credit (HELOC’s): The Basics

When it comes to covering your family’s future educational needs, paying unexpected medical bills, or giving your home a much-needed face-lift, one potential source of funds that is often overlooked is the Home Equity Line of Credit (HELOC). Is getting a HELOC, based on utilizing the available equity in your home, a good idea? The answer is: Maybe, but it is not without risk.

Let’s briefly explore what a HELOC is and why it might make sense to have one.

Home Equity Loans and HELOC’s in short

In brief, Home Equity Loans are closed-end loans and HELOC’s are revolving lines of credit, each being a second mortgage-type loan attached to/secured by the equity in your home (provided your home has equity, which means it is worth more than what you owe on it.)

For example, if your house is worth $150,000 and you owe $70,000, the difference between these two numbers ($150,000 – $70,000 = $80,000) is your “home equity.” Many banks will loan you money utilizing this available equity as collateral (i.e. security for the loan). They may structure it as a lump sum, fixed-payment home equity loan or it may be structured as a flexible home equity line of credit, either of which can be used as you choose.

Referencing the figures above, if your home is worth $150,000, a bank may be willing to lend up to 80% of the home’s value less what you owe. This is known as the CLTV (combined loan to-value) ratio. Banks commonly use this ratio to calculate what you can borrow depicted as follows: $150,000 X 80% = $120,000 CLTV; given the total combined loan value of $120,000 less the $70,000 still owed = $50,000 as available credit. Each bank may have a different policy regarding the maximum CLTV allowable.

Why HELOC’s Rock!

One of the major benefits of a HELOC is its flexibility as a credit line versus a home equity loan’s lump sum with fixed payments. Just as you might use a credit card, you can use the HELOC, pay it down, and use it again, hence the flexibility.

Better still, if you intend to use these funds to enhance your home or make major repairs, financing the improvements with a HELOC is a good idea as you would be making an investment on an existing asset to either maintain or increase its market value. The interest on the line (or even on a regular home equity loan) may be tax deductible. Please consult your tax advisor for more details.

Lastly, since it is essentially a secured, collateralized mortgage loan, the interest rate may be lower compared to most credit cards and other unsecured loans. This means you could choose to use your line of credit to pay off these higher interest rate types of bills and save money on interest.

Contact us at F&M if you would like to discuss the benefits and risks of a Home Equity Loan or HELOC!

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published on 11/6/2019