Advantages and Disadvantages of a Home Equity Line of Credit

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Home equity lines of credit (HELOC) are loans that offer you money to use when you need it and use your home to secure the loan. You can use the proceeds from a home equity line of credit for whatever purpose you need; common uses include home improvements and college tuition expenses. The advantages of an HELOC include having access to money when you need it, a low interest rate and tax benefits, but you must consider that you are using your home as collateral.

Cash When Your Need It

Instead of a large lump sum payment like a home equity loan, you have access to a line of credit with a HELOC, similar to a credit card. This means that you only pay interest on the amount of money that you are borrowing at the time. For example, if you took out a $100,000 home equity loan, you would be paying interest on the entire $100,000, even if you only needed $20,000 now, $20,000 the next year, and $60,000 the year after that. If you had a HELOC with a credit limit of $100,000, you could access the first $20,000 this year so you wouldn't be paying unnecessary interest on the $80,000 you don't need at the moment.

Tax Deductions

The interest on the first $50,000 ($100,000 if you are married and file a joint return) of your home equity loan is deductible from your taxes as an itemized deduction. If you use the proceeds from the loan for home improvements, you can deduct the interest on the first $500,000 ($1 million if you are married and file a joint return) of the loan.

Interest Rates and Credit Limits

The interest rate on an HELOC tends to be almost as low as mortgage interest rates because the loan is backed by your home, rather than other unsecured loans. An HELOC also allows you access to a much larger line of credit than most credit card companies will offer. However, the interest rate may fluctuate based on market conditions so you are exposing yourself to the risk of rates rising. The amount that you can borrow is based on the equity that you have in your home. You can calculate your equity by subtracting any amount you have borrowed against your home, such as a mortgage, from the value of your home. For example, if you home is worth $235,000 and you have $135,000 remaining on your mortgage, you would have $100,000 of equity in your home.

Home as Collateral

When you take out a home equity line of credit, you guarantee that you will repay the loan using your house as collateral. If you fail to meet your debt obligations, the lender can seize your home. Depending on how much you have borrowed, if the value of your home decreases, you may end up owing more money on your home than it is worth.

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About the Author

Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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