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A home equity line of credit (HELOC) can be a good option for short-term borrowing when you’re not sure exactly how much you need — such as home repairs or medical bills. But make sure you can afford the fees and payments, or you’ll risk foreclosure.
A HELOC is a revolving credit line from which you can periodically withdraw money. Lenders let you borrow against your home’s equity and use your home as collateral in case of default.
HELOCs have two payment periods. The draw period is when you can withdraw money and only pay interest on what you borrow. The repayment period is when you’ll start paying back both the principal and interest.
HELOCs usually come with variable interest rates that are tied to a benchmark rate — like the Wall Street Journal prime rate — and fluctuate over time. How much you withdraw determines how much interest you’ll pay, meaning you’ll only accrue interest on the amount of equity you’re actively using.
For instance, if you have a line of credit for $50,000, but you only need $30,000 for a home renovation, you’ll pay interest on the $30,000 and not the $20,000 that you didn’t use. If you spend another $10,000 for vacation, you will pay interest on the total amount withdrawn — $40,000 — with a $10,000 line of credit left over.
Always aim to get the lowest possible interest rate. Some banks charge a margin — or extra percentage points — on top of the benchmark rate. The higher your credit score and the more equity you have, the lower your HELOC margin should be. Shop around to compare lenders. Make sure you’re getting the best deal.
You can also cut down on interest by only borrowing what you absolutely need from your HELOC since interest is calculated on how much you withdraw. To save even more money over the life of your loan, you can make payments on both interest and the principal during the draw period, as well as extra payments during the repayment period.
When you take out money from the HELOC during the draw period, you’ll usually only have to pay interest on the amount you borrowed. Some lenders will allow you to make payments toward the principal as well, which can help reduce the total cost of your HELOC over time. If you decide to make repayments toward the principal, that money can be added back into the line of credit to borrow again.
After the draw period is over, your repayment period begins. This period is when you’ll be on the hook for paying off the total amount you borrowed, plus any interest that accumulated. Be careful, though – the monthly payment amount is much higher during the repayment period than the draw period.
Lenders charge different fees and may be willing to negotiate and waive certain charges. Some of the most common fees associated with HELOCs are:
You’re looking to borrow money with an interest rate that’s typically lower than conventional loans. Periodic withdrawals can be helpful for borrowers who need cash in phases — for example, for a home renovation or to pay for a child’s college tuition. Note that you’ll need at least 15% to 20% equity in your home to qualify.
Most credit unions, banks and private lenders offer HELOCs. You can apply online, in person or over the phone in most cases. You’ll also need to submit documents that verify your information — such as proof of income and home equity — as part of your application.
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