How to Get & Use a Home Equity Line of Credit: A HELOC Is a Short Term Loan that Can Help with Debt Consolidation

For many people, a home equity line of credit is an attractive loan often used for credit card debt consolidation, emergency purchases or buying a car. A HELOC is considered a revolving line of credit that has powerful benefits and potentially severe drawbacks, according to Scott Kays, President of Kays Financial Advisory Corporation in Atlanta, Georgia. Kays is also the author of two books and has appeared on Fox News and CNBC.

What Is a Home Equity Line of Credit?

“Think of it as a credit card, but it’s backed by the equity in your home – the equity of course being the difference between what you owe on it and what the home is worth,” said Kays. “In today’s environment, a bank will let you borrow a total of 90 percent on the value of your house.”

How Does a HELOC Work?

Kays offers a typical scenario as to how home equity lines of credit operate:

  • a borrower has a house valued at $100,000
  • the homeowner owes $80,000 on his first mortgage
  • a lender might let the person borrow $10,000 through a HELOC, leaving 10% equity in the home
  • the $10,000 HELOC is basically an open line of credit that can be borrowed against and paid back at will
  • the borrower can write checks up to the $10,000 credit limit
  • normally the payment that’s due is only the interest, which will usually change month to month

“You can pay principal any time you want to. You can pay it back down to zero,” said Kays.

According to Kays, generally after a ten year period, a HELOC will convert to a fixed loan that must be paid off in a certain period of time. The terms will vary depending on the lender.

 

How to Get the Best Home Equity Line of Credit Rates

The rate for a home equity line of credit is typically tied to the prime rate, which is the lowest rate of interest on loans available from a lender. Many times the HELOC rate is prime plus 1%. However, Kays said he has actually seen HELOC loans that were the prime rate minus 1%.

“Part of it depends on the credit strength of the borrower,” said Kays. “You absolutely should shop around for the best rate. Banks, lenders will certainly vary.”

Some HELOCs might have closing costs, while others will not.

“You definitely want to shop for one where there are no closing costs involved,” said Kays.

Pros of Home Equity Lines of Credit

  • a HELOC typically offers a lower interest rate than credit cards and other loans
  • the interest on home equity lines of credit are almost always tax deductible
  • a HELOC offers flexibility to a borrower in terms of how much he pays back and when
  • the borrower has access to quick cash

“These are perfect for emergencies. These are really not designed to be long term loans,” said Kays.

Cons of Home Equity Lines of Credit

  • a HELOC interest rate is variable
  • if interest rates go up dramatically, the borrower might not have the money to pay back the loan
  • the borrower might use the money to purchase things he’s unable to afford
  • a HELOC is not designed for long term use, like car loans

“Your house is at risk and if you fall behind on the payments on this, you could get your house foreclosed on…That is a downside you have to consider,” said Kays.

According to Kays, home equity lines of credit are powerful tools that, when used wisely, can help a person with debt consolidation or making emergency purchases. However, a HELOC is not designed for long term borrowing, like car loans. It can also put the borrower at risk of losing his house to foreclosure if he fails to make loan payments.