What Is A Home Equity Line Of Credit (HELOC)?
A home equity line of credit (HELOC) is a helpful financial product that can help you tap into the value of your home. If you need to fund a big expense, tapping into the cash value of your home equity might be the solution you’ve been looking for.
While learning more about HELOCs, remember that not all lenders provide these loans. At this time, Rocket Mortgage® does not offer HELOCs.
What Is A HELOC?
A HELOC is a revolving line of credit that allows borrowers to use their home equity for a bigger purchase, debt consolidation or home improvements.
To qualify for this type of second mortgage, you’ll need to have more than 15% – 20% equity in your home at its current appraisal value. You’ll also need a good credit history, a credit score of 620 or higher and a debt-to-income (DTI) ratio in the low 40s, at most.
When you apply for a HELOC, your lender may conduct an appraisal and review property valuation details and information on your local real estate market. If your HELOC application is approved, you’ll be given access to a line of credit.
You can draw funds from the line of credit on an as-needed basis. With that, you won’t need to commit to a particular lump sum. Instead, you can pull the funds you need, up to the credit limit, as you need them.
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How Does A HELOC Work?
A HELOC provides you with an amount of credit based on your equity and might feel more like a credit card than a traditional loan. It’s effectively a pool of money that you can draw upon as needed. Since the credit limit is tied to your home’s equity, it’s a type of second mortgage.
For the sake of clarity, the equity that you have in your residence refers to the difference between how much your house is worth and how much you still owe on your mortgage. You can think of it as the value that you have amassed over time in your home.
In essence, each time you make a mortgage payment (which includes payment on your interest and principal balance), you increase the amount of your home that you own. This is your equity. You have the option to use this equity that you’ve built up over time as collateral to secure a loan. In many cases, using this equity as collateral gives you access to funding at lower rates (and in higher amounts) than you’d find with an unsecured personal loan.
Under the terms of a HELOC, you can borrow money against the equity that you possess in your property and receive revolving credit in exchange. This money can be put toward expenses such as medical care, home improvements, education and world travel. You can even use it to consolidate high-interest credit card debt.
Instead of receiving a lump sum, like with personal loan, a HELOC functions more like a credit card. You’ll be able to borrow up to a preset credit limit and for a set time period (typically 5 – 10 years), with borrowing and repayment split into two specific periods: the draw period and the repayment period.
During the draw period, you can borrow against your line of credit as needed while making minimum or potentially interest-only payments on any amounts borrowed. Should you reach your debt limit, you’ll have to pay down the balance before you’re allowed to borrow more.
Following the draw period’s expiration, the repayment period begins. Generally, HELOCs come with a repayment period between 10 – 20 years attached. During your repayment period, you’ll no longer have access to funds via the HELOC and will be required to make monthly payments until the loan is fully paid off. Any payments made on a HELOC will be submitted in addition to your regular mortgage payment, which is unaffected by the HELOC.
While lenders won’t generally let you borrow against every drop of equity that you hold in your home, terms and conditions of HELOC offers may vary. For example, it’s not uncommon to obtain a 30-year HELOC that comes with a 10-year draw period and 20-year repayment period attached.
Don’t forget that as a type of second mortgage, a HELOC requires you to take out another loan on your property. This is on top of your original mortgage loan, meaning you’ll have two payments. Before taking the plunge and securing a HELOC, you’ll want to crunch the numbers and make sure that signing up for one won’t put a strain on your household budget. If you cannot keep up with the payments for the HELOC, you could lose the home.
Pros And Cons Of A HELOC
As with any form of real estate financial product, a HELOC comes with upsides and downsides. Before obtaining one, weigh the advantages and disadvantages of borrowing against the value that you have accrued in your home under a HELOC. Everyone has a unique situation, so you’ll need to decide what’s best for you.
- Relatively low-cost way to obtain access to additional funding
- Flexibility to use funds for purposes such as education, home improvements and debt consolidation
- Offers ongoing access to the equity you’ve built in your home
- Provides access to potential tax deductions on your annual returns
- Gives you money when needed and time to plan repayment
- Lets you make larger purchases without blowing your monthly budget
- Can make it possible to take out more money and at less expense than under an unsecured personal loan
- This second mortgage uses your home as collateral for access to a line of credit
- Not particularly useful when utilized for one-time use projects
- Lenders may require you to make preset minimum draws against funding, impacting your payments
- Interest rates can be variable
- Variety of fees may apply over time
- Late or missed payments can damage your credit history and score
How To Get A Home Equity Line Of Credit
When applying for a home equity loan, the process can feel a bit like taking out a regular mortgage. If your finances are in good shape, you can start shopping around for a lender. The right lender will offer the funding you need at a competitively low rate.
After selecting a lender, you’ll need to submit an application. Be prepared to provide homeownership documentation and income documentation, like W-2s, pay stubs and tax returns. You’ll also need to provide information on bank or investment accounts that you own.
Additionally, be prepared for the lender to request an appraisal. Before signing on the dotted line, carefully review the loan estimates, terms and expenses.
If approved, you’ll enter the draw period. When drawing down funds, keep the looming repayment period in mind.
Before you start your application, check in with your financial picture.
You can improve your chances of being approved for a HELOC with a high credit score, low debt-to-income ratio, and hold at least 15% – 20% equity in your home. If you don’t have enough equity or have a low credit score, try working on those details before moving forward.
Home Equity Line Of Credit FAQs
Here’s a closer look at your questions about a home equity line of credit.
What’s the difference between a HELOC and a home equity loan?
A home equity line of credit is a revolving line of credit that comes with a credit limit attached. As the homeowner, you can borrow up to the credit limit during the draw period. When the draw period ends, you cannot access the line of credit anymore and you’ll be required to repay the borrowed funds.
In contrast, a home equity loan involves a lump sum of funds that you’ll repay in regular monthly payments. When you take out a home equity loan, you’ll pay interest on the entire lump sum. With a HELOC, you’ll only pay interest on the funds you withdraw from your line of credit.
If considering tapping into your home’s equity, weighing the costs of a HELOC versus a home equity loan is helpful.
What can a home equity line of credit be used for?
Homeowners can use a HELOC for a wide range of expenses. A few ways you can use your HELOC funds include paying for home improvements, consolidating debt, making large purchases, covering medical bills, paying for higher education and more.
What are the alternatives to a HELOC?
A HELOC isn’t the only way to cover expenses. If you aren’t looking to tap into the value of your home, consider a personal loan or credit card. If you’re willing to use your home’s value as collateral, consider a home equity loan. For homeowners who prefer to stick with a single mortgage payment, a cash-out refinance might be the solution.
Should I be borrowing against the equity in my home?
That depends entirely on your financial scenario. If you’ve built up a great deal of home equity, enjoy a relatively stable fiscal situation and are confident in your ability to pay back a HELOC, there’s nothing inherently concerning about this common and routine real estate practice. The key is to plan ahead and not overextend yourself. If you have questions, be sure to consult with a qualified financial professional.
Who is a HELOC best for?
Individuals and households who need access to additional funds over the course of many years may wish to procure a HELOC. Similarly, real estate owners who have many home improvement or property upgrades planned may also wish to obtain a HELOC.
Under all circumstances, you should only apply if you’re comfortable using your home (especially if it’s your primary residence) as collateral with which to secure access to funding. If you fall behind on the HELOC payments, the lender may repossess your home.
Is it better to get a home equity loan or line of credit?
The right choice between a HELOC and home equity loan depends on your financial situation and individual household needs. For instance, a HELOC is good for homeowners who prefer to use and pay back sums on their own schedule, while home equity loans may be more recommendable for those who prefer monthly payments.
As ever, it pays to conduct upfront planning and budgeting before applying for either. Do your research and consider which makes the right sense for you or your family.
Is it better to get a home equity line of credit or pursue a cash-out refinance?
The right choice comes down to your unique situation. A HELOC offers a more flexible way to fund expenses. You can withdraw funds during the draw period up to your credit limit. But if you don’t need as much cash as you anticipated, you don’t have to overborrow.
In contrast, a cash-out refinance involves a set amount of funds upfront. When you refinance, you’ll commit to a larger mortgage with regular monthly payments. You cannot tap into the remaining equity when you need it.
Homeowners looking for more flexibility might prefer a home equity line of credit. But homeowners who want to stick with a single monthly payment might prefer what a cash-out refinance has to offer.
The Bottom Line
A home equity line of credit offers a streamlined way to access the value of your home when you need it. You can use the funds to cover almost any type of expense.
However, committing to a HELOC involves a second mortgage that might not fit into your budget. A cash-out refinance is another option to tap into the value of your home without adding a second monthly payment. If you’re interested in a cash-out refinance, start the refinancing process today.