Home equity lines of credit (HELOCs): Providing money when needed.

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Home equity lines of credit are second mortgages that can be put in place and then used only as needed. They are smart financing vehicles for those who need varying amounts of funding intermittently. Examples include financing a pay-as-you-go home improvement project, paying for college tuition and other expenses, funding a business startup, or just putting a financial safety net in place--an important safeguard for those with irregular or seasonal income who might experience an occasional shortfall.

HELOCs are approved for a maximum loan amount, then the borrower is free to use as much or as little as needed. The credit line can be tapped and repaid over and over. It's this flexibility that makes HELOCs so popular with homeowners. The HELOC interest rate is variable, usually tied to the prime rate, and its monthly payment is determined by the account balance and the interest rate. HELOCs have two stages--the draw period, during which the loan can be tapped and paid as many times as the borrower likes, and then the repayment period, during which the loan must be repaid and the line can no longer be tapped. Draw periods range from 5 to 10 years, and repayment periods from 10 to 20 years.

HELOCs for Home Improvement

The flexible nature of this loan makes it perfect for purchasing materials and paying for labor. By using a credit card to pay for building supplies, then tapping the HELOC to pay the credit card balance, the homeowner can take advantage of the card's interest-free grace period while paying the lower HELOC interest rate. And when weather makes projects impossible, the balance can be paid down and monthly outgo minimized.

HELOCs for College

The HELOC makes it easy to deal with college expenses--it can be tapped for tuition and other fees, repaid, then tapped again next year. With a fixed rate second mortgage, the homeowner would have to initiate new loans each year or take out one large loan and pay interest on the entire balance.

HELOCs for Businesses

Employees and suppliers need to be paid, even when the biggest customer's check is still "in the mail." A HELOC can make starting a new business a little less harrowing by smoothing things out until cash flows become more regular and predictable.

HELOCs as Safety Nets

For those with commission or seasonal income, having a HELOC in place can provide peace of mind. It's better to pre-arrange financing to head off potential cash flow glitches, rather than waiting until financial problems make it too difficult or expensive to get emergency financing.

Disadvantages:  The HELOC's variable rate can cause uncertainty and financial hardship if rates increase dramatically. The variation in rate and account balance can also make it harder to budget with a HELOC. Newer versions of this loan include features that allow borrowers to fix the rate at one or more specific times during the life of the loan.

Advantages: The HELOC's chief advantage is its flexibility. Borrowers only pay interest on funds actually used. Those who need varying amounts of cash at intermittent times can save money by not paying for credit when they don't need it. New versions of the loan also take some of the uncertainty of the variable rate out of the picture by allowing borrowers to fix their rate at certain times (usually but not always the repayment phase) during the life of the loan. A HELOC can be used as a hedge against future financial hiccups, and help homeowners avoid credit-rating problems created by a temporary cash shortage. 

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