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What is HELOC and How Does It Work?

Anyone who’s bought a house knows that it costs an absolute fortune. The average price of a home in the U.S. has shot up to $300,000 in recent years — and that’s not even counting property taxes, monthly mortgage payments, maintenance costs and other common expenses.

Even if you manage to get your hands on a mortgage with favorable terms (which is easier said than done these days), you still need sufficient cash up front to secure said loan. That’s where a HELOC comes into play.

What is a HELOC?

According to themortgagereports.com, HELOC is a type of second mortgage specifically designed for borrowers who have equity in their primary residence. While they may seem like an obscure way to save up for that down payment, there are several top reasons why you should take advantage of one if you own a house and can secure one as well.

They’re user-friendly, affordable and flexible – perfect for any homeowner who needs cash fast but doesn’t want to sell their home or take on too much debt from another lender.

How Does a HELOC work?

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In laymans terms, having a home equity line of credit means you are borrowing against the available equity on your home. However, always make sure you can make the payments easily because your house is the collateral for the loan.

A home equity line of credit is flexible in terms of the borrowing amount. You can borrow as much or as little as you need at the time, but be careful about the repayment time and affordability. There are a few things you should know before applying for this type of loan.

Make Sure Your Credit is Good Before Applying

Before even considering a HELOC, make sure that your credit history is in good standing. Depending on how healthy your financial profile is, you may be able to get a traditional loan with no money down — but, unfortunately, most lenders are looking for higher credit scores these days.

What’s more, HELOCs specifically focus on your home equity, meaning your credit score isn’t taken as heavily into account — making them an ideal financing choice for those with less-than-stellar credit. If your credit is bad or you have no credit history, you might want to consider other options for financing your home down payment.

Be Careful with Using HELOCs for Down Payments

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If you have bad credit and can only qualify for a HELOC, be very careful with how much money you tap your account for. Credit lenders take the first $100,000 of equity on a homeowner’s property into account before they start charging interest, which is definitely a benefit.

However, if you’re tapping a HELOC for a house down payment, you could find yourself owing thousands of dollars in interest on the money that you borrowed. That’s why you need to be careful about how much money you tap from your account.

Aim to only borrow enough to cover the down payment and a little extra for closing costs — and never, ever take out more than you need. If you over-extend yourself and can’t pay the debt back, you could end up losing your home.

You Can Leverage a HELOC for Home Repairs and Renovations

HELOCs are often used for down payments because they’re quick and easy to obtain. Unfortunately, they also have short repayment timelines — and while they’re suitable for short-term projects like repairs, they’re not a good choice for something that’s expected to take months or years to complete.

If you’re in need of a large amount of money for renovations or repairs to your home, consider tapping your HELOC for a down payment and then finding another lender for the rest. You can use the money from the HELOC to get the project started and then pay it back as soon as you can. That way, not only do you have the money you need for repairs, but you also have shorter term on the loan — allowing you to finish the project sooner.

Don’t Ever Use Your HELOC for Day-to-Day Living Expenses

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When you tap your HELOC for a down payment, you’re essentially getting a short-term loan with no interest — and that’s great. It means you won’t have to pay back any more than what you borrowed.

Unfortunately, that also means that you need to be careful not to spend the money in any way — as any expenses paid out of the HELOC will need to be repaid as well. If you tap your HELOC for day-to-day living expenses, you run the risk of not being able to pay the debt back.

Once you fall behind, that short-term loan will turn into a much larger long-term one — complete with interest. That’s why it’s important to only use your HELOC for the down payment and a little extra for closing costs while using it for absolutely nothing else.

Conclusion

HELOCs are an excellent way of securing a down payment for a house. Not only do they allow you to borrow against the equity in your home, but the money that you borrow will not have to be repaid immediately like with a traditional mortgage.

HELOCs work well for those who have good credit and who need to borrow a large amount of money. While they do have a minimum amount that must be borrowed, it is usually less than what is required for a traditional mortgage.

If you’re looking to buy a house, a HELOC can be a great way to bridge the gap between the amount of money you have saved up for a down payment and how much you need to actually secure the loan.

Whether you’re trying to make repairs or renovations to your home or upgrading the appliances, a HELOC can be an excellent way to get the money you need without having to sell your home or take on a large amount of debt from another lender.

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