Similar to a credit card, a home equity line of credit could be the answer for home owners who are looking to take out a second mortgage. A home equity line of credit has several unique features and more flexibility than regular home loans, so it might be a better choice for those who need a second mortgage.
What is a Home Equity Line of Credit?
A home equity line of credit (HELOC) gives home owners the possibility of borrowing against the equity in their home. The borrower doesn’t receive the whole loan amount upfront. The lender will establish a line of credit from which the borrower can withdraw, up to the agreed total amount, much like when using a credit card.
The loan is given out based on the borrower’s credit score and equity available in his home. Home equity lines of credit, which are different than home equity loans, usually last for 5 to 10 years in which you can withdraw the amount that you need, for which you will be charged interest. Interest will not be charged for the whole credit line available, but only for the amount that you are actually borrowing. The period in which you can use the money is called a draw period, and it is followed by the repayment period. Repayment periods usually last 10 to 20 years, but some home equity lines of credit require payment at the end of the draw period.
Because a home equity line of credit allows you to withdraw as much as you want, within the set limit, the interest on this type of loan will be calculated daily, rather than monthly.
Benefits of a Home Equity Line of Credit
HELOCs have several strong advantages which should make this type of home loan a good choice for your second mortgage. Here are the most notable:
- You will be charged interest only on the amount of money that you use, and not the whole credit line amount. The interest, which is tax deductible, will also be lower initially than it would be on a regular mortgage loan. There are, however, a few fees associated with setting up the loan and keeping the line of credit open.
- Applying for a HELOC is a very simple process and the fees are much lower than on a conventional mortgage loan.
- Withdrawing funds from a HELOC is as easy as using your own bank account. You can just use the money through a debit card or by writing checks.
- Home equity lines of credit are also a good option for home owners who wish to make repairs or start a home improvement project, pay for education or medical expenses.
Drawbacks of a Home Equity Line of Credit
Home equity lines of credit are not the perfect loan, so they do have some disadvantages, as well. Here are the ones that you should keep in mind:
- HELOCs are riskier than adjustable-rate mortgages, meaning that the interest rate can significantly increase over night. Interest rates change during the draw period, unlike ARMs, which give you a fixed rate for at least 5 years.
- Paying a low interest in the beginning can be a trap for those who don’t have a good budget plan. The interest might be much higher when the time comes to pay off the principle.
As long as you are disciplined, understand what a home equity line of credit involves, and what are its advantages and disadvantages, this type of loan might be a great choice when you need a second mortgage.