A home equity line of credit, or HELOC, is a great financial tool that allows homeowners to tap into their available equity as needed. HELOCs work similarly to credit cards in that you have access to a credit line — up to a certain limit — and can spend as much or as little as you wish.
While HELOCs typically have lower interest rates than most credit cards or personal loans, they use your home as collateral to secure the loan. If you aren’t prepared to make payments on your loan when it enters repayment, you could be in for a surprise once your monthly payments increase.
If you need the cash to finance a home renovation project or to consolidate debt, then a home equity line of credit may be worth considering. Here’s what you need to know about HELOCs to help you decide if it’s the right fit for you.
What is a HELOC Loan?
A home equity line of credit is a type of loan that allows a homeowner to take out a revolving line of credit against the equity in their home. HELOCs typically have lower interest rates than other types of loans and the interest may also be tax deductible if you use those funds to make improvements to your home.
HELOCs are secured loans, meaning that the borrower’s home is used as collateral to secure the loan. Because the home is used as collateral, failure to repay the HELOC could lead to foreclosure.
What is a HELOC Used For?
Many homeowners use HELOC funds to cover large expenses like home improvement projects, college, medical bills, new business ventures, and high-interest debt consolidation. While there are no restrictions on how you can use this money, it may not be the best idea to use your home equity to fund a lifestyle you cannot afford, like fancy vacations or expensive cars.
If you default on a HELOC, your lender could foreclose on your home. Not only would you lose your home, but your credit score would take a significant hit and the foreclosure would remain on your credit report for seven years from the date of your first missed payment.
How Does a HELOC Work?
Similar to a credit card, a HELOC is a revolving line of credit with a variable interest rate that homeowners can access at any time they choose. Upon approval, you will receive a credit limit based on your credit score and the available equity in your home. In most cases, homeowners can borrow up to 85% of their home’s value minus what is owed on the mortgage.
To access HELOC funds, your lender will provide you with several options including:
- HELOC account card
- Online account transfer
- Check
- Cash withdrawal from bank
- Account transfer request via phone
HELOCs have two phases: the draw period and the repayment period.
- Draw period: After you take out a HELOC, you are in what is known as the “draw period”. This is the only time you are allowed to access your available credit. Draw periods can last five to 10 years depending on the terms of the loan. Most lenders will require you to make interest payments during the draw period, but some may request minimum monthly payments.
- Repayment period: After the draw period, you will enter the repayment period, which typically lasts 10 to 20 years. This is when you will be required to repay what you borrowed, plus interest. Some HELOCs also have a balloon payment, which is a large lump-sum payment made toward the end of the loan term.
Your interest rate will most likely be a variable interest rate, which can fluctuate over time. This means your payment can change from month to month. Some lenders offer fixed-rate HELOCs, but these loans may come with restrictions.
Borrowers need to be prepared for when the draw period ends. Planning ahead can help ensure you are financially capable of repaying your HELOC and your mortgage at the same time.
Interested in learning if you qualify for a home loan? Find a Total Mortgage branch near you and speak to a mortgage advisor to discuss your loan options.
What are HELOC Requirements?
To qualify for a HELOC, you will need to meet certain requirements. Most lenders have their own set of criteria, but these are general HELOC requirements:
- Equity: You must have at least 15%-20% equity in your home.
- Credit score: A credit score of at least 700 is ideal.
- Income: Lenders like to see stable income and that you will be capable of repaying your loan.
- DTI ratio: Lenders want to see a debt-to-income (DTI) ratio of 45% or less. The lower your DTI, the better.
- Payment history: It may be difficult to qualify if you have a history of late payments.
- Appraisal: Most lenders will require an appraisal before approving a HELOC. The lender needs to know the current value of your home to calculate the amount you can borrow.
HELOC vs Home Equity Loan
A home equity loan is another tool available to homeowners that accesses their home equity. But while a HELOC gives homeowners a line of credit to use as needed, a home equity loan provides funds in a single lump sum. Home equity loans also have fixed monthly payments that begin after the proceeds are disbursed, whereas HELOC payment amounts can change over time.
A HELOC may be a better choice if you need flexibility and prefer to borrow as needed. However, a home equity loan could be better if you know the exact amount needed and prefer a fixed interest rate.
Put Your Equity to Work With Total Mortgage
A HELOC lets you borrow what you need, which makes them a good choice for repairs, renovations, investments, or other large purchases. HELOCs have lower interest rates than most credit cards and personal loans, but homeowners should be prepared to make payments once the loan goes into repayment.
Are you ready to put your equity to work? Start your application with Total Mortgage and get your free rate quote after answering a few questions.
Source: totalmortgage.com