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Home Equity Line of Credit
Home Equity Line of Credit (HELOC)
Advantages of a HELOC
As with any loan, a HELOC should only be used when it makes sense and the person borrowing the money is responsible. There are many advantages to a HELCOC versus other forms of credit. For one, you can get a much better interest rate because it is tied directly to you home and the interest paid is likely tax deductable. Please consult with your accountant to make sure your situation will allow for the interest to be tax deductable. The HELOC is a great tool to pay off and eliminate debt if the account is used properly. For example, many homeowners will use the HELOC to consolidate credit cards and other unsecured forms of credit to get a lower payment with much better terms.
Open End versus Closed End Loans
The mortgage you have on your home is a closed end loan which means the payment you make does not affect the interest you owe for that month, regardless of how early you make the payment. The only only way to pay off a closed end loan early is to make additional payments throughout the loan. A HELOC is a open end loan which means the interest due for the month must be recalculated at the time a payment is received, regardless of the amount of the payment. If you made two or three smaller payments during the month, the interest owed must be recalculated as soon as each payment is received. Therefore, a HELOC can help you eliminate interest on your debt at a much faster rate than a closed end loan where interest will not be recalculated during the month the payment was received.
Disadvantage of a HELOC
The greatest disadvantage is when the borrower is not act responsibly. For example, the homeowner will pay off credit cards and other unsecured debt to get the lower payment and rates and within a short time, start charging things to their credit cards again. Now you must be back the HELOC and you are right back in the position of debt again. Credit cards can be a huge advantage in debt reduction if the amount charged each month can and will be paid off every month. It is very expensive to use a credit card and not pay off the balance every month.