A home equity line of credit, also called a term loan, a home equity line, or HELOC, is an unusual type of loan compared to the ones you may be used to. While most loans are for a fixed dollar amount, a HELOC loan is for a maximum amount — as in, you can withdraw up to a certain amount, depending on how much you need. You borrow this money against the equity of your house.
For the duration of the loan, you can draw this money by using a check or debit card, just as you might draw money out of your checking account. At the end, you pay it back, plus interest.
Because a HELOC loan is unique, and not everyone takes one out, there are a number of misconceptions about them and how they work. Here are six common HELOC myths, along with the truth about these loans.
Myth #1: You can only get a HELOC loan for a second mortgage.
Traditionally, HELOC loans were generally given to homeowners who took out a second mortgage on their house, to refinance their original mortgage. However, an increasing number of HELOC loans are given as the first mortgage you take out on a home.
But be aware that this can be very risky. A HELOC loan offers you no protection against changing interest rates. If the interest rate changes considerably, you may be saddled with a responsibility to pay back a far larger sum of money than you anticipated.
Myth #2: HELOC loans are only good for home improvement projects.
To be sure, this is the most common use of a HELOC loan. To many people, it makes a lot of sense to borrow money against the value of your home, to improve the value of your home.
But this isn’t the only use for a HELOC loan. You can technically take out a HELOC loan for any reason, any time you need any money. Just be ready to pay it back.
Myth #3: Once you get a HELOC loan, the amount of money you can take out through your HELOC loan can’t change.
Many people assume that once they receive a HELOC loan, the amount of money available to them through the loan will never change. Unfortunately, this isn’t true.
The amount of money you can get through a HELOC loan is taken out of your home’s equity. If your home’s value decreases, you may see a decrease in the amount of money you can take out through your HELOC loan. Likewise, if your credit score takes a severe hit, you may see your lender take action by reducing the amount of money available to you through your HELOC loan.
Myth #4: A HELOC loan is basically a reserve of cash.
On the surface, this is true: you can withdraw money from the money allotted to you in your HELOC loan by following the same procedures you might follow to withdraw money from a checking account or by spending money on your credit card. However, there are some key differences.
For instance, the money available to you through your HELOC loan is only available to you for a set amount of time. If you haven’t spent it during that time, the amount of money is no longer available (which is not a bad thing — you won’t have to pay that money off). If your conditions change, your bank can change the terms of your HELOC loan or change the amount of money available to you. Your financial institution can even freeze your HELOC loan account in extreme cases.
You must also pay interest on the money you withdraw. You’ll likely also be given a series of terms and conditions you must abide by with regards to your HELOC loan. None of these apply when you’re spending your own money!
Myth #5: You can pull out all of the equity in your home, using a HELOC loan.
Most financial institutions won’t allow you to do this (it’s called “100-percent financing”). Most lenders impose a cap on the amount of money you can take out, which is typically between 70 percent and 85 percent of your home’s value.
Though this may seem irritating, it’s actually a good thing. Spending all your home’s equity would be very financially risky. The more you take out, the more you have to pay back — with interest.
Myth #6: It’s a good idea to take out a HELOC loan because you never know if you’ll need the money.
HELOC loans aren’t free. Like many loans, there are closing costs. These are usually less than you’d pay to close a normal mortgage, but they aren’t cheap, either.
Many HELOC loans require a minimum draw when you first take out the loan. There’s often an annual fee you have to pay as well as a cancellation fee due if you cancel the loan. None of these fees are very high, but your HELOC loan definitely isn’t free money — and that’s leaving aside the repayment and interest rates you’ll have to take care of later.
HELOC loans aren’t for everyone, but they’re a valuable way of getting a line of credit if you need one. If you still have questions about HELOC loans, reach out to us and we’ll help you out. If you’re ready to get started, apply for a HELOC loan here.