Why Every Homeowner Should Have a HELOC Ready to Go
If you buy a home , chances are it will be your biggest asset – possibly ever. I often stop and wonder why someone loaned me and my wife the money to buy a house, but we managed, and then, a few years after buying this house, a hurricane swept through and turned our first floor into an aquarium. As I stood there inspecting the damp damage and wondering how we were going to pay for the stunning renovations, I remembered that we took out a home equity line of credit (HELOC) when we bought the house, and it saved our relationship. butts.
HELOC is different from a home loan – instead of a lump sum payment to your account with a (usually) fixed interest rate, HELOCs are open-ended lines of credit with a floating rate. They can remain dormant, meaning you can open one and never use it, and they usually have a 10 to 15 year draw period. And you only pay interest on the money you actually use. That’s why you should have it ready to use.
emergency funds
HELOC can be critical when an unforeseen emergency occurs. When people think of HELOC they mostly think of home renovations and that is how most HELOCs are used. This makes sense since you are borrowing from the value of your home to increase its value. But HELOCs can also be emergency reserve funds that can help you financially get through an emergency.
When the hurricane destroyed our home, we knew that the cost of taking everything out, cleaning it for mold, and then putting everything back – I mean everything down to the floors – would be astronomical. We had flood insurance, but it took months to get a check from her. Our HELOC allowed us to start mold removal immediately and our home was renovated in just two months because we didn’t have to wait for the insurer. Meanwhile, we didn’t have to empty our savings account while we waited for our insurance payout.
It is extremely important to have a HELOC ready – setting up a HELOC is like applying for any other loan and the process can take months, which will do you no good when you are dealing with an emergency. Because you don’t need to access your HELOC – ever – you can have this line of credit and pay nothing for it until you actually have to use it. And interest rates on HELOC tend to be lower than mortgage loans because you’re collateralizing your home, so there’s less risk for your lender (more on that in a moment). And because you only pay interest on the amount you actually use, it can be a very accurate financial instrument—and not just in times of disaster. You can use HELOC for anything you don’t have immediate funds for, such as a medical emergency, unexpected unemployment, or unexpected home repairs.
disadvantages
While having HELOC on hand is a good idea to weather unexpected financial disasters, there are a few things to consider:
Risk. You should only use your HELOC funds as a kind of “bridging loan” – as in my personal example when we used it pending an insurance claim we were certain of – and only when you need to act quickly. Your home is HELOC’s collateral, so if you default on the lender’s obligations, you can foreclose it. If you have the time, a personal loan or other form of credit is a less risky choice.
Rates. HEOCs are usually variable rate loans, so your monthly payments can change suddenly. Even if you are comfortable with debt, you may end up paying more for the loan than you bargained for.
Term. Most HELOCs are broken down into two terms. Initially, these are credit lines that you can use at any time (the so-called “use period”). After this period (usually 10-15 years) there is a “repayment period”. You can no longer use them, but you must repay the principal plus monthly interest. That’s why using HELOC is a bad idea unless you know you can pay it off relatively quickly – otherwise it could turn into significant debt. Once again, your house is at stake.
That being said, having a line of credit ready to go can be critical in the event of an emergency. Being able to shell out significant sums of money without delay can be the difference between a quick recovery and continued suffering. Just make sure you don’t jump over your head.