These are challenging times. New information is coming out on a daily basis. There is a good chance that the way you run your personal life today is not the way you were running it when the new year started. We asked our writers to create articles that help you run your personal life while maintaining your social distancing. We will be adding new articles every week.
No one could have foreseen the impact of a sudden pandemic on the world's largest economy. The damage has been widespread with no industry and few individuals escaping the economic carnage. The government stimulus payments and the extra unemployment benefits have provided much-needed lifelines, but, as the virus lingers, many people are turning to other sources to help meet their expenses. One source that is being tapped more than in the recent past is home equity. As a result of the COVID-19 crisis, interest rates are at historic lows, making home equity lines of credit (HELOC) an affordable option.
How a HELOC Works
To understand how a HELOC works, think of your credit cards. You're given an unsecured line of credit against which you can borrow to make a purchase. When you pay it back, you replenish your line of credit. For that convenience, credit card companies charge a higher rate of interest than other forms of borrowing.
A HELOC is very similar. You are given a secured line of credit based on the equity value of your house. You could be approved for a line up to 80% of the equity value. You should have at least 20% equity in your home for a HELCO to be an option. But you only borrow what you need, and the line is replenished when you repay it. For that convenience, the interest rates are a bit higher than what you might pay on a fixed home equity loan, plus they are variable, which could increase your interest costs if interest rates rise. Fees charged by lenders for a HELOC are generally very low.
When a HELOC May Make Sense
As the economy continues to struggle, many people have already blown through their emergency funds. Some are resorting to tapping their retirement account (as temporarily allowed through the CARES Act). The only other option available may be to borrow money, which is not ideal. But, if you have sufficient equity in your home, a HELOC may make sense. Because lenders rely more on your equity, your credit score is less of a factor in getting approved. It's certainly a better option than high-interest credit cards. And it offers more flexibility than a fixed home equity loan or personal loan.
What makes it ideal is you only have to draw down what you need in a week or month to cover your shortfall. You simply write a check. That allows you to control your interest costs. You can make a minimum payment, which may be interest-only. Or, as cash rolls in, you can pay the line off more quickly.
When a HELOC May Not Make Sense
The most significant risk with a HELCO is that you could lose your home if you are unable to repay it. If you think your income may be further impacted as the crisis lingers on, it may not be the best option. You should especially avoid HELOCs that come with a balloon payment.
Another risk is that the lender could freeze your HELOC is housing prices fall too much. That's what happened during the 2008 financial crisis. The housing markets in most areas are much more stable now, but a slowing economy could drive housing prices down.
HELOCs come with variable interest rates, which means, if interest rates increase, your interest costs will increase. That's probably a small risk in the current environment, which is keeping interest rates low.
Finally, the application and approval process for getting a HELOC could take several weeks. If you need cash more quickly, you may have to look at other short-term options, such as a personal loan, which can be obtained within a few days. The interest rates are higher, but their fees are generally very low.
Be Sure to Shop and Compare HELOCs
Most lending institutions offer HELOCs. You should plan on speaking with at least three lenders to carefully compare interest rates and fees, such as loan origination charges. Look out for restrictive terms, such as scheduled withdrawal periods and balloon payments.
Your home is your largest asset, and the equity in your home can be your biggest source of cash when you need it. There might be cheaper loan options, such as cash-out refinancing, if you need to pay down credit card debt, but none offer the flexibility and convenience of a HELOC.