In the modern world, debt is, unfortunately, pervasive and comes in myriad forms. According to CoreLogic, about 5.1 million homes have mortgages which possess negative equity. In other words, rather than be a valuable financial asset, homes for many families have become a liability. Further, the number of American households which possess credit card debt amounts to nearly 40%.
Worse, as of 2018, approximately 44 million Americans hold student loan debt which totals nearly one and a half trillion dollars. In total, Americans owe 12.96 trillion dollars worth of debt, which breaks down to over $130,00 per household.
What Debt Does to Your Wealth and Health
Problems which come with having high amounts of debt are varied and can be experienced in both the short- and long-term. To begin, having outstanding debt will adversely affect your credit rating. In fact, on average, persistent debt may drop your credit score by as much as 30%!
Further, since debt should be paid off to avoid long-range consequences, it, in effect, reduces potential future spending. Worse, since most forms of debt often require interest payments, you are going to spend more just to get out of the red than you would on some other form of consumption in the future.
On top of all of that, debt can even affect your health. According to polling, individuals with debt experience substantially higher rates of migraines, anxiety, severe depression, and even ulcers.
To summarize, debt is a severe problem which everyone should address as quickly and efficiently as possible. That said, tackling debt can be a psychologically distressing undertaking and typically requires an extensive understanding of personal finance.
Fortunately, for homeowners there is a different stratagem one can pursue is a home equity line of credit, commonly abbreviated as HELOC.
So, What is HELOC?
A HELOC is a form of debt consolidation which can be used to pay off a variety of obligations including student loan debt or credit card debt. Based off of the market value of your home, plus the equity of your home which you own, a HELOC grants the recipient a line of credit from which they can spend up to a certain predetermined limit. So long as it is within the pre-approved limit, the HELOC borrower can withdraw however much money they need within in a set time frame.
In essence, HELOC is a form of a bank loan in which the sum given may vary over the course of the lending period, rather than just be a single lump sum given all at once. Like any other loan, though, a HELOC must be paid back with interest. HELOC interest rates can be variable, but are predominantly structured around prime interest rates.
Aside from paying down debt, one of the most common reasons people apply for a HELOC is to either repair or upgrade their home. In the former case, the recipient is protecting the value of their house while also gaining some value long-term given home appreciation. In the latter case, they are considerably raising the value of their home in the form of new additions or modifications. In both cases, the recipient can extract a considerable amount of cash which might not be available to the HELOC recipient.
Also, HELOC’s can be used to finance expensive ventures such as college loans or provide a line of credit for a startup business.
What Makes HELOC Different from Similar Strategies to Consolidate Debt?
Besides a HELOC scheme, there are other, similar means to leverage one’s household value to attain capital quickly. The two most similar loans being cash-out refinancing and a home equity loan. Like a HELOC they have certain advantages and disadvantages.
Cash out Refinance vs HELOC
Before we compare it vital ask, how does cash out refinance work? Based off of how much their mortgage a homeowner has paid, someone may get a loan less than or equal to the equity they own on their house which is added to the remaining amount of money on the home’s mortgage.
However, restrictions such as stringent credit requirements may make attain these types of loans difficult for some. In general, a HELOC or even a home equity loan is a better route to travel.
Home Equity Line of Credit vs Home Equity Loan
Essentially, a home equity loan is nearly identical to a HELOC plan with a few exceptions, the most notable one being that a home equity loan provides a single lump sum up front. In addition to that, home equity loan interest rates cannot be adjusted at all. It is worth noting as well, that as implied previously, a HELOC can have either an adjustable or fixed interest rate, but this depends on the lender.
However, both are in many respects a form of a second mortgage.
Concerning the question of which of the two being preferable, a HELOC vs home equity loan, that depends on circumstance. A loan based off of home value can be a good way to pay off a debt or conduct a home improvement project if the total cost has been calculated. On the other hand, HELOC may be a better way to pay for major home repairs or provide some form of emergency capital if the necessary amount of money needed is unknown.