Home Equity Line Of Credit (HELOC): Everything You Need To Know
A home equity line of credit (HELOC) is a handy financial tool that can help you bankroll home renovations, access extra funds for education, or even pay for upcoming travel. It offers homeowners a way to access cash by tapping into existing equity in their home, providing you with additional money for expenses.
An easy way to think of a HELOC is as a line of credit you can use toward the payoff of large expenses like DIY home upgrades or retirement travel. A ready way to get your hands on a large chunk of cash without taking out a personal loan, it provides greater flexibility and financial wherewithal for real estate owners by allowing them to tap into equity that they possess in their property.
In effect, if you’re a homeowner who over time has made a sizable down payment, steadily paid off your mortgage, and continued to pay down your property’s monthly billing statement, you’ll likely have built up equity in your home. Rather than obtaining funding from a personal loan provider or credit card company, tapping into a HELOC allows you to borrow cash against the value that you have accrued in your property to date.
While Rocket Mortgage® does not offer HELOCs, it's important as a consumer to understand how they work should you bein the market for one.
How Does a Home Equity Line Of Credit Work?
A HELOC provides you with an amount of revolving credit that works more akin to a credit card than a loan. It’s effectively a pool of money that you can draw upon as needed that’s tied to your home’s equity.
For 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. Better still, using this equity as collateral gives you access to funding at lower rates (and in higher amounts) than is typical 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 in a different fashion. In essence, 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, which we’ll get into more below.
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.
Note that it’s important to do extensive research and budgeting prior to applying for a HELOC. Although it can prove a handy tool for helping you access extra funds and give your monthly budget more breathing room, don’t forget that as a type of second mortgage, a HELOC requires you to take out another loan on your property in addition to the mortgage loan that you currently possess. 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.
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To qualify for a HELOC, you’ll need to have more than 15 – 20% equity in your home at its current appraisal value. You will also need a good credit history, credit score of 620 or higher, and a debt-to-income (DTI) ratio in the low 40s or lower.
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. Should your HELOC application be approved, you’ll be given access to a line of credit.
The Draw 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 are allowed to borrow more.
Functioning in similar fashion to a credit card, a HELOC will let you borrow up to 80% of your home’s value for the life of the loan. A balance will be carried forward from one month to the next during the draw period, which generally lasts between 5-10 years, during which time you can borrow as much or little as you like. Minimum payments (sometimes interest-only payments) will be charged on the amount of funds that you have utilized.
The Repayment Period
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. Be advised, however: Some HELOCs may require you to pay the entire balance in the form of a lump sum (balloon) payment when your draw period ends.
Contemplating applying for a HELOC? Do your research and be certain that you fully understand what repayment terms come attached to the loan before seeking to obtain one.
Common HELOC Uses
As noted, a HELOC can provide you with extra funds for use with paying off both everyday household and recurring expenses. Likewise, it can be used for paying off high-ticket purchases and unexpected costs. Here are a few specific examples of what a HELOC can be used for:
- Home improvements
- Property upgrades
- Debt consolidation
- Large purchases
- Medical bills and elder care
- Tuition costs and higher education
- Travel and hospitality
Difference Between A Home Equity Loan And Line Of Credit
Confused by what the difference is between a home equity loan and a home equity line of credit? We don’t blame you, especially as both are common forms of second mortgages.
It may help to consider that under a HELOC, you are given access to revolving credit for which interest is only charged on monies borrowed. In contrast, a home equity loan is a long-term loan on which interest is charged on the full balance of a lump sum of money lent for the lifetime of the loan.
How To Calculate Home Equity Line Of Credit
Wondering how to calculate how much you can obtain in funding through a HELOC? Here’s how:
Step 1: Multiply your home’s value times the percentage value that your lender allows you to borrow. This is the maximum equity that can be borrowed.
Step 2: Subtract the remaining mortgage balance from the maximum equity that can be borrowed This is the total amount you can borrow.
For example, say you get a HELOC with an 80% loan-to-value (LTV) ratio. Your home is worth $300,000 and you currently owe $150,000. To figure out how much your credit limit would be on this HELOC, multiply your home’s value by 80% and subtract your current balance.
$300,000 X .80 = $240,000
$240,000 – $150,000 = $90,000
Under the terms of this scenario, you could potentially apply for a credit limit of up to $90,000.
How To Get A Home Equity Line Of Credit
Applying for a HELOC doesn’t have to be difficult. However, you’ll have to meet some minimum qualifications, and do a little planning, budgeting, and research.
Qualifying For A HELOC
Applying For A HELOC
As with applying for your first mortgage, you’ll want to start the process by compiling all necessary documentation and shopping around for a lender. Applying for a HELOC will require you to submit documentation that proves home ownership and establishes your income (for example, W-2s, pay stubs and tax returns), and provide information on bank or investment accounts that you own.
As part of the process, you can expect to review loan estimates and terms, get an appraisal done and participate in closing.
Paying A HELOC Back
As above, you’ll make minimum payments during the draw period, and larger payments during the repayment period. Note that you can pay principal balances down during the draw period to lower interest payments during the repayment period as well.
As stated above, some HELOCs may come with a large balloon payment attached at the end of the loan period to boot. Should you find yourself unable to afford this balloon payment, you can attempt to negotiate an extension on the loan or seek to refinance.
What Are The Pros And Cons Of HELOCs?
As with any form of real estate financial product, a HELOC comes with upsides and downsides. Before obtaining one, acquaint yourself with the advantages and disadvantages of borrowing against the value that you have accrued in your home under a HELOC.
The Pros Of HELOCs
- Relatively low-cost way to obtain access to additional funding
- Flexibility to use funds for purposes such as education, home improvements and debt consolidation
- Provides access to potential tax deductions on your annual returns
- Gives you money when needed and time to plot 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
The Cons Of HELOCs
- As a form of second mortgage, uses your home as collateral for access to 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 rating
Many frequently asked questions (FAQs) surround the use of HELOCs and the variety of purposes to which they can be put. Several of the most common are noted and answered below.
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 home equity line of credit. Similarly, real estate owners who have many home improvement or property upgrades planned may also wish to obtain a HELOC. Under all circumstances though, you’ll wish to apply only if you are comfortable using your home (especially if it’s your primary residence) as collateral with which to secure access to funding.
Is it better to get a home equity loan or line of credit?
The right choice between a HELOC vs. a 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.
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.
In fact, millions of homeowners who need ongoing or extensive access to capital do it every day. The key is to plan ahead and not overextend yourself – if you have questions, be sure to consult with a qualified financial professional.
The Bottom Line
A home equity line of credit offers a simple, straightforward way to access revolving credit on an ongoing basis. You can use it to obtain money needed to fund home improvements, education and other high-ticket expenses. Allowing you to borrow against existing equity in your home, it’s a useful tool for anyone who needs access to cash.
Functioning like credit cards, HELOCs offer funding at lower interest rates and in higher amounts than unsecured personal loans. However, they come with ups and downs attached and whether they make sense for you depends on your financial situation.
Need access to money in a pinch? We encourage you to do your research, shop around and review and compare loan terms before taking out a HELOC. Similarly, you may wish to explore alternative funding options such as a mortgage refinance.