A home equity line of credit (HELOC) can be a great lending option for homeowners who have built up a significant amount of home equity. As you pay down your mortgage loan, you are reducing the principal balance of what you owe. Over time, your property may also appreciate in value. It is likely worth more now than when you bought it. This leaves you with home equity—the difference between the current market value of your home and how much you still owe on your mortgage loan.

Having home equity can give you a lot of leverage as a homeowner. You can even utilize your home equity to cash-out or borrow money that can be used for other expenses. A HELOC is one solution that enables you to take out some of your equity in the form of cash or credit.

what is a HELOC loan

What is a Home Equity Line of Credit?

A HELOC is a line of credit that uses your home equity as collateral. You are able to borrow and withdraw funds as you need them, up to a set credit limit. You can use your HELOC money to invest back into your property with improvements, upgrades and renovations — which in turn may increase its value (and your potential home equity) even more over time.

Or, you can use the funds to pay off other high-interest debts like credit cards, student loans or car loans. It can be used for anything you want. Other common examples are college expenses for your children or unexpected family medical bills.

How Much Can I Borrow with a HELOC?

Your home equity line of credit limit will be based on your available home equity and your current mortgage balance. Mortgage lenders will typically allow you to borrow up to 85% of your home’s value minus your outstanding mortgage principal balance.

Let’s say your home appraises for $500,000 and you currently owe $300,000 on your mortgage loan. The difference between these two amounts is your home equity, which is $200,000. If you are approved for a HELOC up to 85% of the home’s value (85% of $500,000 = $425,000) minus what you owe ($300,000), then your HELOC limit will be $125,000.

Mortgage lenders and banks will review other financial factors when determining your HELOC eligibility, HELOC interest rate and credit limit. They will look at your current income, existing debts and your credit rating (FICO score). You will need to go through an approval and underwriting process just like you did with your original mortgage.

HELOC Interest Rates

Home equity line of credit interest rates are usually higher than normal mortgage rates. This is still considered a second loan and presents more risk to lenders on top of the original mortgage amount you still owe. The good news is HELOC rates are generally lower than home equity loan rates. We will provide a more thorough comparison between HELOCs vs. home equity loans a little later in this article.

HELOCs typically have variable interest rates, much like credit cards. The interest rate on your HELOC may go up and down based on prevailing consumer credit and mortgage rates. The rate will fluctuate, as will the cost of your credit as you borrow funds from the credit line.

How Do I Repay a HELOC?

Most HELOC draw period last for 10 years. You are able to take out money when you need it over this draw period, which allows you to control how much you borrow at any given time as long as the total stays under your HELOC limit. Monthly, interest-only payments will be required based on your principal balance. You are welcome to pay more than just the interest at any time if you want to pay down some or all of your principal balance. Any paid-down principal will also replenish the funds in the credit line that you can borrow in the future.

After the draw period ends, you will begin repaying the principal balance that has accrued. You will no longer be able to draw funds from the credit line. This is when you must pay off the principal and interest based on what you have borrowed. Most HELOC payoff terms will be 10 or 20 years.

Remember that a HELOC is a loan and it is using your house and its equity as collateral. Just like any mortgage or second mortgage, you are responsible for making your payments from month to month. Any failure to repay can result in penalties, liens and even foreclosure.

How to Apply for a HELOC

Applying for a home equity line of credit is similar to applying for all types of mortgage loans. You will reach out to your mortgage lender, mortgage broker or bank and submit an application. Your lender will review your financial documentation, run a credit score and determine if you are a qualified HELOC candidate.

In general, a credit score of at least 620 is required to qualify for a HELOC. A credit score of 700 or higher will benefit you even more—likely with a lower interest rate and better payoff terms. The lender will also review your debt-to-income (DTI) ratio (average monthly debt payments vs. average monthly pre-tax income). Ultimately, the mortgage lender is protecting both the borrower and themselves. They are making sure you will be able to pay back the loan before they can issue this line of credit.

Steps to Getting a HELOC

If you are looking to apply for a home equity line of credit, here are the steps that will need to be taken:

  1. Figure out your budget — Determine how much you need to borrow and why. Never take out more than you actually need.
  2. Get your documentation in order — You will want to have financial records ready, including recent pay stubs, proof of any self-employment income, tax returns for the past two years, and current bank statements.
  3. Talk to your lender — Talk with your mortgage broker, lender or bank and ask if a HELOC is the right solution for you. Consult with multiple lenders and get multiple estimates, as each may offer different interest rates, fees and eligibility requirements.
  4. Apply — Once you’ve gotten yourself ready and have chosen a lender, you can apply for your HELOC loan. Your lender will walk you through this process.
  5. Get your home appraised — Your lender will hire a certified home appraiser to determine the current market value of your property. This determines your home equity and will be necessary in setting your HELOC limit.
  6. Loan approval — The HELOC will go through the lender’s final underwriting and review process. You will sign the paperwork and the credit line will be approved.
  7. Withdraw cash — Once the HELOC is closed and your right of recession period has passed, you will be able to start withdrawing funds. You can access funds by writing a check, making online transfers or with a special HELOC debit/credit card attached to your credit line.

HELOC Alternatives

Home equity lines of credit are not the ideal solution for every homeowner. It depends on your home equity, your personal financial situation, your existing mortgage principal balance and other factors. Here’s how HELOCs compare to other methods of turning your home equity into cash.

HELOC vs. Home Equity Loan

A home equity loan (aka “second mortgage”) is similar to a HELOC in the sense it lets you borrow from your equity. However, it is a traditional lump-sum cash loan using your home equity as collateral. You borrow a fixed amount of money based on your approved limit and you get it all at once. However, you will generally be required to start paying it back right away. How much your monthly payments are will depend on the loan amount and term.

The repayment period can be 5, 10, 15 or even 20 years based on the loan amount and other factors. You will immediately start paying back your home equity loan principal plus interest. You will be making these payments simultaneously, but separately, from your normal mortgage payments. It is a separate loan. Compared to HELOCs, home equity loans generally have higher interest rates. The main reason to get a home equity loan is if you need the cash as soon as possible rather than having a line of credit.

HELOC vs. Cash-Out Refinance

Cash-out refinancing is another lending solution for homeowners with good home equity and strong financial standing. A cash-out refinance loan will allow you to cash out a portion of your home equity. This amount borrowed is added to your current mortgage loan principal. They are combined together as one new refinanced mortgage loan with one monthly payment. Cash-out refinancing generally offers better mortgage rates compared to home equity loans or HELOCs, especially if you qualify at a lower interest rate than your original loan.HELOC Alternatives

Home equity lines of credit are not the ideal solution for every homeowner. It depends on your home equity, your personal financial situation, your existing mortgage principal balance and other factors. Here’s how HELOCs compare to other methods of turning your home equity into cash.

HELOC vs. Reverse Mortgage

For homeowners over the age of 62, a reverse mortgage may be another available alternative to a HELOC, home equity loan or cash-out refinance. This type of loan allows you to borrow from your home equity in the form of monthly payments. Essentially, the lender pays you a set amount each month until you eventually sell the house, move or pass away. The loan is only repaid when the house is sold.

This is a good option for senior homeowners who need extra income for basic living expenses, but you have to be very careful if considering a reverse mortgage. Depending on how you want to receive and spend the money, a HELOC or home equity loan may be a better solution.

HELOC vs. Credit Card

Lastly, let’s consider the benefits of a HELOC against a standard credit card. It’s typically much easier to apply for an be approved for a credit card. It’s not hard to get a line of credit these days. However, credit card interest rates are extremely high and it is really easy to make minimum payments and dig yourself deeper into debt. In addition, most credit card limits will not be as high as what you can borrow with a HELOC.

The home equity line of credit is issued based on your home equity, which gives you more collateral and leverage as a borrower. If you are eligible for a HELOC, it will almost always be a better option than a credit card. The same is true for home equity loans, reverse mortgages, cash-out refinances and even personal loans.

Additional HELOC Information for Potential Borrowers

If you are a homeowner and want to know more about home equity lines of credit (HELOCs) or other ways to tap into your home equity, contact Moreira Team today. We can help you explore your options and find the lending solution that is right for you and your unique situation.