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A home equity line of credit (HELOC) is a loan that is secured by the borrower’s home. Put another way, the homeowner is borrowing against the equity in their house. The money can be used for nearly anything, although the funds are typically spent on home improvements and other major expenses.
For many homeowners, a HELOC is a valuable tool for meeting significant financial and personal goals. However, it’s important for all borrowers to understand the basics of HELOCs first before utilizing them, as they can have certain drawbacks and may require you to make changes to your estate plan.
How Does a HELOC Work?
Many homes have equity, which is the difference between the current market value of the house and the total balance of all outstanding loans that are secured by the home. Homeowners can borrow against this equity by way of a HELOC, with the house securing the loan as collateral. As the borrower repays the loan, the amount of available credit increases. This is similar to how a credit card works.
The homeowner can therefore continue to borrow more money if they need to. In fact, the homeowner can borrow as much or as little as they want during the draw period, up to the credit limit. The draw period is commonly 10 years, and the borrower will only have to repay the interest on what they borrow during that time. At the end of the draw period, the full repayment period begins, and it typically lasts about 20 years.
Is a HELOC a Good Idea?
Although HELOCs are useful ways of accessing funds for necessary expenditures, there are potential drawbacks. Before you borrow, it’s important understand a few of the advantages and disadvantages of the HELOC.
Pros
- Lower interest rates: Because the borrower’s house serves as the collateral for the loan, the HELOC allows the lender to take more risk and therefore extend a lower interest rate compared to credit cards and unsecured loans.
- Flexibility: HELOCs should not be confused with the similarly named home equity loan, by which the borrower can only borrow a fixed amount of money up front. As a line of credit, the HELOC lets the homeowner borrow what they need (up to the credit limit) during the 10-year draw period. Paying down the balance increases the available credit and lets you borrow more until the repayment period starts.
- Easy access: HELOC lenders typically allow borrowers to access funds in various ways, including debit cards, credit cards, checks, branch and ATM withdrawals, and online transfers. This makes it much easier to use the line of credit and therefore lets the borrower spend the money on a broad array of expenses.
- Long repayment period: The HELOC usually comes with a considerably longer repayment period compared to other types of loans. In some cases, these periods may be as long as 25 years, depending on the lender. This helps make the monthly repayments more affordable and easier to plan for.
- Possible tax deduction: Certain expenses that borrowers make with their HELOC funds may qualify them for tax deductions. For instance, if the borrower uses the money to make renovations or home improvements, the interest could be tax-deductible if the taxpayer itemizes deductions.
Cons
- Variable interest rates: HELOC interest rates often vary, although it may be possible to acquire a fixed rate for part of the credit line during the draw period. Variable rates can be difficult for families trying to budget because the payments are typically not the same each month. Payments may also be less affordable if the borrower only paid interest during the draw period.
- Risk of foreclosure (and losing your home): As with any other collateral, there is a risk you could lose it by defaulting on your loan. The difference, of course, is that the collateral in this case is your home. The lender has the right to foreclose on your home if you cannot make payments, so it’s important to understand the terms of the HELOC before you sign.
- Decreased home equity: A HELOC reduces your available equity, which may not be a problem if your home is located in a strong market. But if the market weakens and the value of your home decreases, you could end up being underwater on the mortgage (owing more than the house is worth). The lender can also freeze your line of credit if it believes you will no longer be able to make your monthly payments.
- Fees: You will likely need to pay a number of fees, both to secure the HELOC in the first place and to keep it. These include closing costs and annual fees to maintain the line of credit. You should also know whether your lender charges an inactivity fee for not making enough withdrawals or an early cancellation fee if you terminate the credit line early.
- Credit impact: Not only do HELOC lenders generally require good credit (typically a 660 score or higher), but the HELOC itself will impact your score. This includes when you open the credit line and use the HELOC funds. As with any other loan, your credit score will also decrease if you fall behind on your payments.
How Can You Get a HELOC If Your Home Is In a Trust?
The heightened requirements for a HELOC approval can be frustrating, and they may make it more difficult for the borrower to use the money for what they need. But the delays and stress can be avoided if you retain an estate planning attorney early in the process. Our firm can help you get a HELOC on a house that is held in a trust. When you work with us, we can:
- Temporarily remove the property from the trust: Waiting until after your HELOC is approved—or worse, right before closing—can delay the process and create gaps in your estate plan. The earlier we’re involved, the better.The lender may require this anyway, our team can help in this process..
- Move the home back into the trust: Once your HELOC is approved and you close on the loan, you can move the home back into the trust. We can take care of the deed transfer and keep you apprised of its status.
- Keep your estate plan on track: From applying for and repaying your HELOC, you need to make sure your estate plan continues to serve you and your family. We play an active role in keeping your plan intact and aligned with your long-term goals.
When to Call FEPLG (Sooner Than You Think)
Taking a home out of a trust may seem to be an unusual step, but if it is not done properly, it can cause delays and disrupt your estate plan. That is why we always tell our clients to call us early in the process, before applying for a HELOC or refinancing. Our experienced estate planning team can help you meet your lender’s requirements, avoid last-minute issues, and keep your estate plan on track. Reach out to our team to get started. We are here to make the process clear and stress-free.
