A home equity line of credit is sometimes called a HELOC for short, and is not to be confused with a home equity loan. Though the two sound similar, they work in fundamentally different ways.
A HELOC uses the equity you have in your home as a line of credit. This essentially means that you can borrow as much money as you want, as and when you see fit, so long as it is within your home equity limit. What makes a HELOC good is that you only pay interest on the money you actually borrow, and not the limit overall. In this sense, it is similar to applying for a credit card with a very high limit. You pay interest only as you spend any of your HELOC’s funds.
For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, then you have $200,000 worth of equity in your home. A HELOC allows you to borrow amounts of money (as regularly or irregularly as you want) within this $200,000 limit. If, for example, you spend $50,000 of this $200,000 limit, and your interest rate is 5%, then you will have to pay back $52,500 altogether. The remaining $150,000 of the HELOC (that you haven’t used) is ignored when it comes to interest. You would only pay interest on the entire amount if you actually used the entire $200,000 limit. It’s worth noting that some HELOCs use percentages of your home equity (for example a 50% HELOC, in this case, would be $100,000) so be sure to check which option may be best for you.
HELOCs are good for getting immediate cash, and this is what many people and investors use them for. HELOCs are often used by wise investors to pay down payments on investment properties. HELOCs are also tax deductible, meaning that any interest you pay on them can be deducted from your tax liability. The interest rates on HELOCs tend to be fairly low, but watch out for variable interest rates, as many HELOCs come with interest rates that could suddenly spike and leave you in the red. Uniquely, you can also pay off a HELOC entirely, and then re-borrow the money all over again.
All of these factors make HELOCs a good way to build credit, especially if you have a poor credit history and are finding it hard to rebuild your credit via other methods. As with any loan though, be sure to pay your HELOC payments on time, otherwise, you will damage your credit score. It’s also worth considering that HELOCs, while generally less risky than other loans, are still using your home as collateral. If you fail to pay your HELOC payments on time, you inevitably risk foreclosure. While the aforementioned factors make HELOCs tempting, always remember that you are risking your home in the process.