Owning a home brings the advantage of a valuable financial resource – building equity. This equity can be tapped into through a second mortgage, like a one-time loan or a revolving HELOC. However, each option also has drawbacks, so you must weigh them before deciding.
In this blog post, we’ll explore HELOC’s ins and outs to guide you on using your home equity wisely. Get to know HELOC, learn its importance, and optimize your home equity for financial stability.
What is a HELOC Loan?
A HELOC is a secure and flexible loan tied to your home. It’s secured because your home backs it, meaning if you miss payments, the lender can take your home. It’s revolving credit, allowing you to borrow up to a limit without using it all at once.
For example, you could borrow for a bathroom renovation and later borrow more for a different expense. Think of it like a credit card but tied to your home.
How Does a HELOC Work?
A HELOC typically has two phases: a 10-year draw period for accessing credit, with small interest-only payments. After, it enters a 20-year repayment phase, where you pay both principal and interest.
Beware of potential payment shock when the repayment period starts, as payments may nearly double, causing financial strain and potential default. Defaulting on payments can lead to losing your home.
HELOC vs Home Equity Loans
Both HELOC and home equity loans use home equity as collateral but differ in key aspects.
|Home Equity Line of Credit (HELOC)||Home Equity Loan|
|How and when you access funds||Access funds as needed, like revolving credit (like a credit card).||Receive the full loan amount at once.|
|Also called||HELOC||Second mortgage|
|Maximum amount you can borrow||65% of your home’s value||80% of your home’s value minus your outstanding mortgage|
|Type of interest rate||Variable rate only||Variable or fixed rates|
|Can you borrow more after paying back what you borrowed?||Yes||No, you’ll need to apply for another home equity loan|
Types of Home Equity Line of Credit HELOC
There are 2 main types of Home Equity Lines of Credit (HELOCs): one combined with a mortgage and another as a stand-alone product.
Combined with a Mortgage
- Offered by major financial institutions, it’s known as a readvanceable mortgage.
- Combines a revolving HELOC with a fixed-term mortgage.
- No fixed repayment amounts for the HELOC; interest is paid on the amount used.
- Your credit limit can go up to 65% of what you paid for your home, and it increases as you pay off more of your mortgage.
- A revolving credit product not tied to your mortgage.
- Maximum credit limit can be up to 65% of your home’s purchase price.
- Unlike the combined option, the credit limit doesn’t increase as you pay down the mortgage principal.
- Available from any lender offering stand-alone HELOCs.
Advantages and Disadvantages of a HELOC
HELOC offers both advantages and disadvantages for homeowners. Understanding these aspects is crucial when considering this financial tool.
- Easy access to credit.
- Typically lower interest HELOC rates than unsecured loans or credit cards.
- Pay interest only on what you borrow.
- No prepayment penalty; you can repay anytime.
- Flexible borrowing up to your credit limit.
- Tailor it to fit your specific borrowing needs.
- Consolidate debts at potentially lower rates.
- Requires disciplined repayment, often with monthly interest-only payments.
- Access to large credit limits may lead to prolonged debt.
- Switching mortgages may require paying off the full HELOC.
- Missing payments, even with a repayment plan, can result in home possession by the lender.
Become Eligible for A Line of Credit for Home Equity
To secure a Home Equity Line of Credit (HELOC), you only need approval once, granting you easy access thereafter. Here’s what you’ll need:
- A minimum down payment of 20%, or 35%, for a stand-alone HELOC substituting a mortgage. Approval based on:
- A satisfactory credit score.
- Proof of stable income.
- Manageable debt-to-income ratio.
- To get the thumbs-up from the bank, they’ll do a “stress test” to make sure you can handle the payments at a specific interest rate. Some credit unions might also use this test.
The stress test uses the higher of 5.25% or your negotiated interest rate plus 2%. If leveraging your home’s equity, you must also:
- Prove home ownership.
- Provide mortgage details.
- Have your home’s value assessed.
Legal assistance is needed to register your home as collateral. Consult your lender for further guidance.
How Much Am I Eligible to Borrow?
When considering a Home Equity Loan, you must assess your borrowing capacity. Like the process of figuring out affordability when searching for a new home, Home Equity Loans consider key factors such as your income and expenses.
This evaluation determines the maximum amount you can qualify to borrow, ensuring a realistic and manageable financial commitment.
Do Your Calculations
Use our Mortgage Calculator to quickly determine the maximum amount you qualify for based on your income and expenses. Whether you’re buying a new home or tapping into your equity, it’s a straightforward tool for understanding your financial scope.
Frequently Asked Questions About Home Equity Line Credit (HELOC)
Does a HELOC require repayment?
Repayment of a home equity line of credit is an absolute requirement. To close the account, you must repay the entire amount you borrowed, even though HELOCs normally only require interest-only payments. Interest will continue to be paid on your loan until you do.
What level of credit is required to be eligible for a HELOC?
Although lenders have different requirements, 620 on a credit score is typically sufficient. Lower interest rates are typically associated with better credit scores. A lender will assess your total debt load and need you to pass a stress test before deciding how big of a HELOC to give you.
Turn Home Equity into Financial Flexibility Today
Understanding the ins and outs of HELOC is crucial, and with the right knowledge, you can use your home’s equity to discover exciting possibilities. Your home is not just a place to live; it’s an asset waiting to be strategically utilized.