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A home equity line of credit (HELOC) is a loan secured by your home or another residential property you own. It allows you to borrow against the equity you have in your home, using the funds to pay for home improvements, consolidate debt, or even just cover monthly bills.
In this post:
- Here’s how a HELOC works
- How you can use HELOCs
- Is a home equity line of credit right for you?
- How to apply for a HELOC
- An alternative to consider
Here’s how a HELOC works
Unlike other home loans, you’re not given a lump-sum right from the start with a HELOC. Instead, you have a line of credit you can draw from as needed (much like a credit card). You can pull from that credit line as much as you want up to the maximum amount during the “draw period” and then you’ll pay off your balance once the “repayment period” begins. HELOCs often have a 10-year draw period.
The amount you can borrow on a HELOC varies based on how much equity you have in your home and other factors. Generally, most lenders offer credit lines around 75% to 85% of your home’s appraised value, minus any outstanding loan balance you have on your first or second mortgage.
Let’s say your home is valued at $250,000:
$250,000 x 75% = $187,500
And you owe $120,000 on your first mortgage:
$187,500 – $120,000 = $67,500
In the above scenario, assuming your lender caps the maximum loan-to-value ratio of 75%, you could potentially qualify for a HELOC with a maximum credit line of $67,500.
How you can use HELOCs
You don’t have to use your line of credit for any specific type of expense. Many homeowners use it for renovations or repairs, while others use them as a way to pay off high-interest debt (like credit cards).
HELOCs can also be helpful for homeowners facing financial hardship — though it does come with some risks.
Is a home equity line of credit right for you?
HELOCs aren’t always the right move for everyone. For one, they put your home at risk. Should you be unable to repay your balance once the draw period comes to a close, your lender could foreclose on the property.
Additionally, HELOCs come with upfront costs, too, including an application fee, costs for appraisals and title searches, and more. Because getting a HELOC adds to your credit balances, they can also hurt your credit score.
Ultimately, here are some scenarios when you might want to consider a HELOC — and when you’d want to steer clear:
HELOCs are best when:
- You want to renovate or make repairs. Using a home equity line of credit toward home improvements comes with unique tax benefits. If you use your HELOC funds to increase your home’s value, you might be able to write off any interest you pay on your annual taxes. You should always consult with a tax professional, however.
- You’re buying another property. HELOCs can ease the homebuying process if you’re purchasing a second home, vacation property, or some other real estate investment. Use the funds from your HELOC toward the down payment and closing costs for the second home, and only pay interest on what you borrow.
- You can afford the costs. HELOCs don’t come for free. There are both upfront costs and, in many cases, maintenance, membership, and per-transaction costs. Make sure you’ll have the income necessary to meet your obligations both at closing and over the course of your draw period.
Think twice before getting a HELOC if:
- You’re prone to flippant spending. Just like credit cards, HELOCs come with temptation. If you can’t trust yourself with a large line of credit, you might want to avoid one altogether.
- You don’t need much cash. If you’re only looking for a small amount of money, keep in mind that the origination charges on a HELOC might exceed how much you’re planning to borrow. If that’s the case, a credit card might be a better option — especially if you can find one with a zero- or low-interest promotional period.
- You’re unsure about your future earnings. If there’s any uncertainty about whether you can meet your payment obligations down the line, avoid taking out a HELOC secured by your home. It could put you at risk of foreclosure.
- Home values are declining around you. If your home loses value, it cuts down on how much equity you have. If it falls too much, you might end up owing more money on the loans secured by your home than your home’s worth.
HELOCs aren’t the only way to tap your home equity. If a HELOC isn’t the right move, a cash-out refinance or home equity loan might be a good alternative.
Learn More: Home Equity Loan vs. Home Equity Line of Credit (HELOC)
How to apply for a HELOC
If a HELOC is a good fit for your personal situation, your first step is to determine how much equity you have. To do this, just subtract your mortgage balance from your home’s appraised value.
If the difference is more than 15% to 25% of your home’s appraised value, you could qualify for a HELOC. Your best bet for determining the appraised value is to use the appraisal from when you purchased the house or the last time you refinanced the property — whichever is most recent.
If you have enough equity in your home to warrant a HELOC, you can follow these steps to apply:
- Shop around for a lender. As with any loan product, rates and terms on HELOCs vary, so comparing your options is key if you want the best deal.
- Gather your documentation. You’ll need bank statements, pay stubs, and other financial paperwork.
- Fill out the application. Complete your chosen lender’s application. Many lenders offer fully online processes these days.
- Work with your loan officer. Your loan officer will guide the rest of the process. They might ask for more documentation or order an appraisal of your property.
- Close on your loan. Finally, sign your closing documents, pay any fees owed, and open your line of credit.
An alternative to consider
A cash-out mortgage refinance can be a good option to consider if you’d get a lower interest rate than with your current mortgage. Even if the interest rate on your new loan is higher than your existing mortgage, a cash-out mortgage refinance might make sense if you need funds to pay off other debt or fund a home improvement project. Always compare offers first, so you can find the right loan for your situation.
Although Credible Operations, Inc. doesn’t offer HELOCs currently, you can compare cash-out refinancing offers quickly and easily.
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