What is a HELOC?

March 7, 2007 at 02:21:12 PM
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First off, thank you Silvia for bringing me back to reality, I guess some of the terminology I have used in past blog posts are a little confusing and I should have stated more clearly where I was going with my comment. Well, at least it has inspired me to break down what a HELOC (Home Equity Line of Credit) is, and how homeowners and investors can use it to your advantage.
What is a HELOC?
In my opinion, the most effective way to compare a HELOC to something else if to compare it to a credit card. The difference being that the credit card in unsecured, and the HELOC is secured by the equity in your home. They have a similar function, access to a pre-determined amount of money, which costs a certain rate, and will be paid back on a certain schedule. That is where the similiarities really end. A HELOC is a line of credit tied to your property, allowing you to access your equity, to use as you please. Typically the HELOC's interest rate is tied to the Prime Rate, that nasty thing Alan Greenspan seemed to increase every few months forever. The actual rate will be determined by the Value of the Home compared to the amount you are borrowing, your credit score, and the type of documentation used to qualify. The rate is usually expressed in a value below or over prime. Meaning, if the prime rate is 8.25% (which it is right now), and you are getting a HELOC at .25% below prime, your rate would be 8%. Make sense?
How can you use the HELOC?
That really is up to you. The smart way to use it is for remodeling, improving the house, or investing. The common way to use it is to pay off credit cards, cars, and toys. I feel, you should use equity to best suit your life. If you are swamped with bills, feel overwhelmed because of the car payment, and the HELOC will give you some relieve by combining them all into one loan, then make it work for you. But don't keep building that debt. You need to set a serious goal that you are going to pay down that HELOC. Adding onto the debt, is the downward spiral towards real problems, I am sure you all have seen or heard it lately.
The way investors use HELOC's to their advantage, and make a killing in real estate, is by leveraging their properties with the HELOC, and buying more property. Real investors aren't affraid of debt, they are affraid of losing cash. Real investors would rather use other people's money to invest, and keep their own. Why you say? ROI (Return on Investment). One of the first things I learned about in college, and what was stressed to me, is to maximize ROI, and the way to do it is with other people's money. The HELOC is the best way to make this happen. Flippers (people who buy houses for a period of time, fix it, and sell it) use HELOC's to leverage properties, buy supplies, and then sell. They try to avoid using their own cash. Yes, it does cost more in interest, but the cost of interest is worth it when they are only in the property for a number of months.
You can also use a HELOC in case of emergency. Something I recommend heavily. If your car breaks down, if you get sick, or if you need to buy a new refrigerator, you can use a HELOC to purchase that item, and the likelihood you will pay off the purchase is higher if you were to use a HELOC than if you were to use a Credit Card because of the interest cost. It should be much lower than a Credit Card with a HELOC.
There are endless ways you can use it, if you need any advice on whether it can benefit you, let me know.
Tags: Prime, HELOC, Home Equity Line of Credit, Interest, Credit Card, Debt Consolidation
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