May 14th, 2019 11:56 AM by Jackie A. Graves, President
A home equity line of credit, or HELOC, is a
second mortgage that turns home value into cash you can access as needed.
home equity line of credit, or HELOC, is a second mortgage that gives you
access to cash based on the value of your home. You can draw from a home equity
line of credit and repay all or some of it monthly, somewhat like a credit
a HELOC, you borrow against your equity, which is the home’s value minus the
amount you owe on the primary mortgage. This means:
You could lose the home to
foreclosure if you don’t make the payments because you use the home as
best reason to get a home equity line of credit is for something like a major
repair or remodeling project that increases the value of your home. A reason
not to get a HELOC is the risk of losing your home if you can’t pay back what
To get a home equity line of credit, you’ll typically need a debt-to-income ratioin
the lower 40s or less, a credit score of
620 or higher and home value that’s at least 15% more than you owe.
like a credit card that allows you to borrow against your spending limit as
often as needed, a HELOC gives you the flexibility to borrow against your home
equity, repay and repeat.
you have a $500,000 home with a balance of $300,000 on your first mortgage and
your lender is allowing you to access up to 85% of your home’s equity. You can
establish a HELOC with up to a $125,000 limit:
$500,000 x 85% = $425,000.
HELOCs have variable interest rates. This means that as baseline interest rates
go up or down, the interest rate on your HELOC will adjust, too.
set your rate, the lender will start with an index rate, like the prime rate or
Libor (a benchmark rate used by many banks), then add a markup depending on
your credit profile. Variable rates leave you vulnerable to rising interest
rates, so be sure to take this into account.
you pay back a home equity line of credit?
HELOC has two phases. First is the draw period, followed by the repayment
During the draw
period, you can borrow from the credit line by checkbook
or card. The minimum payments often are interest-only, but you can pay
principal if you wish. The length of the draw period varies; it’s often 10
During the repayment period, you
no longer borrow against the credit line. Instead, you pay it back in monthly
installments that include principal and interest. With the addition of
principal, the monthly payments can rise sharply compared with the draw period.
The length of the repayment period varies; it’s often 20 years.
While a HELOC behaves like a revolving line of credit, letting you
tap your home’s value in just the amount you need as you need it, a home equity loan
provides a lump-sum withdrawal that’s paid back in installments.
loans are usually issued with a fixed interest rate. This can save you future
payment shocks if interest rates are rising. Work with your lender to decide which
option is best for your financing needs.
A HELOC is often used for home repairs and
renovations. A bonus: The interest on your HELOC may be tax-deductible if
you use the money to buy, build or substantially improve your home, according
to the IRS.
Some use home
equity lines of credit to pay for education. Financial advisors generally don’t
recommend using a HELOC to pay for vacations and cars because those
expenditures don’t build wealth, and may put you at risk of losing the home if
you default on the loan.
to avoid a home equity line of credit
HELOC introduces the risk of foreclosure if you can’t pay the loan. Consider
tapping an emergency fund or taking out a personal loan instead.
of your goal, avoid a HELOC if:
Your income is unstable. If
it’s possible that your income will change for the worse, a HELOC may be a bad
idea. If you can’t keep up with your monthly payments, a lender might force you
out of your home.
You can’t afford the
upfront costs. A HELOC may require an application fee, title search,
appraisal, attorney’s fees and points. These charges can set you back hundreds
You aren’t looking to
borrow much money. Those upfront costs may not be worth it if you need only a
small line of credit. In that case, you may be better off with a low-interest credit
card, perhaps with an introductory interest-free period.
You can’t afford an
interest rate increase. HELOCs have adjustable rates. The loan paperwork will
disclose the lifetime cap, which is the highest-possible rate. Could you afford
that? If not, think twice about getting the loan.
You’re using it for basic
you need extra money for day-to-day purchases, and you’re having trouble just
making ends meet, a HELOC isn’t worth the risk. Get your finances in shape
before taking on additional debts.
the best HELOC rate
one’s on you: The more you research, the bigger your reward. As you look for
the best deal on a home equity line of credit interest rate, get quotes from
make sure your credit score is in good shape. Then, check your primary bank or
mortgage provider; it might offer discounts to existing customers. Get a quote
and compare its rates with at least two other lenders. As you shop around, take
note of introductory offers, initial rates that will expire at the end of a
Look into the caps on your interest rate, both the lifetime cap,
and a periodic cap if it applies. Caps are the maximum limits on interest rate
The annual percentage
rate on your HELOC is most likely variable; it fluctuates with
the market. Make sure you know the maximum rate you could pay — and that you
can afford the payments based on it.
Steps for getting a home equity line of credit
Since a HELOC
is a second mortgage, the process of getting one is similar to that of getting
a mortgage to buy or refinance a home. You’ll provide some of the same
documentation and demonstrate that you’re creditworthy. Here are the steps
Determine whether you have
sufficient equity, using a HELOC
Once you determine that you have
enough equity, shop HELOC lenders.
Gather your documentation before
you apply so the process will go smoothly. See this checklist of
documents needed for a mortgage preapproval.
Once you have pulled together
your documentation and selected a lender, apply for the HELOC.
You’ll receive disclosures. Read
them carefully and ask the lender questions. Make sure the HELOC will fit your
needs. For example, does it require you to borrow thousands of dollars upfront
(often called an initial draw)? Do you have to open a separate bank account to
get the best rate on the HELOC?
The underwriting process can take
hours to weeks, and may involve getting an appraisal.
The final step is the loan
closing when you sign paperwork and the line of credit becomes available.
HELOC affects your credit score
a HELOC acts a lot like a credit card, giving you ongoing access to your home’s
equity, there’s one big difference when it comes to your credit score: Some
bureaus treat HELOCs of a certain size like installment loans rather than
revolving lines of credit.
means borrowing 100% of your HELOC limit may not have the same negative effect
as maxing out your credit card. Like any line of credit, a new HELOC on your
report will likely reduce your credit score temporarily.
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