What You Should Know About Your Home Equity Line of Credit
A home equity line of credit, also known as a HELOC, allows homeowners to borrow money from a line of credit backed by the equity in the home. A HELOC can help pay for college tuition each semester, ongoing home improvement projects or any other purpose the homeowner desires.
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Repayment Terms
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Before opening a HELOC, the homeowner should understand how and when the money will need to be repaid. HELOCs generally have a draw period where the homeowner can use the line of credit in a manner similar to a credit card and make monthly payments as low as interest only. At the end of the draw period, the homeowner either enters the repayment period with equal monthly payments to pay off the loan balance or has a balloon payment, meaning that the full amount borrowed is due immediately. Understand the repayment terms so you do not get caught off guard when payments are due.
Interest Rate
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The interest rate on a home equity line of credit is usually a variable rate, meaning that it fluctuates with a published interest rate, typically the prime rate. If you open a line of credit when interest rates are low and borrow money assuming you have a great interest rate, you could get stuck repaying it at a much higher interest rate later. In addition, some HELOCs have a 6-month introductory rate that is lower than the ongoing rate. Base your borrowing on what you can afford to pay when the rate goes up, not on what you can afford when the rate is low.
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Tax Advantages
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If you itemize deductions on your income tax return, your home equity line of credit can pay off. This is because interest you pay on your HELOC qualifies as an itemized deduction. However, this is only true for the first $100,000 of home equity debt on your primary residence. In addition, if you owe more on your house than it is worth, you cannot claim interest paid on debt that is greater than your home's fair market value.
Dangers
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Your home equity line of credit does not just provide you with free money. Rather, you are borrowing against the equity in your home. When you sell your home, part of the proceeds will go toward repaying the HELOC, leaving you with less money. In addition, if you fail to make payments on the HELOC as agreed, the lender can take steps to foreclose on your home. You should only borrow with a home equity line of credit if you are confident you will be able to make payments.
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