A Home Equity Line of Credit (often called a Home Equity Line or HELOC) is a line of credit that allows you to borrow against the equity you have in your home.
How it Works
Like a credit card, a HELOC lets you borrow up to a certain limit, pay it off, and then borrow again. That limit is determined by a percentage that the lender sets for you called the LTV (loan-to-value). The LTV is the ratio of how much you owe on your home (your current mortgage balance) versus how much it’s actually worth. The amount of money that a bank or credit union will allow you to borrow through a HELOC will depend on what they set as their maximum acceptable LTV—usually in the neighborhood of 80-90%.
HELOC vs Credit Card
While it’s similar to a credit card, a HELOC works slightly differently. One difference is that HELOCs have a time limit. First, there’s the draw period, typically a 10-year phase during which you can withdraw and use the money. You’ll often still need to make payments during this phase and those payments will go toward interest.
Second, is the repayment period, that usually lasts 10 to 20 years. Once you reach this period, you’ll no longer be able to borrow money through your HELOC and will automatically start repaying the principal and interest you’ve accumulated. If you decide to sell your house and move before the repayment period is over or before you’ve paid everything back, the remaining balance will be due before you close.
Qualifying for a HELOC
In order to qualify, you’ll need to prove to your potential lender that you will be able to pay back any money you borrow. Your lender will consider your debt to income ratio (DTI), your credit score, and more. The lender that you choose for your HELOC does not have to be the same as your mortgage provider.
Understanding the Risks
Before jumping into a HELOC, it’s important to be aware of the risks associated with it. First and foremost, remember that you’re putting your home up as collateral in exchange for the credit line. This means that if your situation changes drastically and you’re suddenly unable to make your payments, you risk losing your home. Secondly, as you use your HELOC, you reduce the equity in your home, essentially lowering the amount of your house that you own and increasing the debt that you owe against it.
Another thing to consider is that a HELOC isn’t free money. As with a credit card or any other means of borrowing, you’ll be charged interest. While the rate on a HELOC is typically comparatively low—making it one of the most affordable ways to borrow—keep in mind that the rate is variable and will fluctuate over time as the Prime rate changes.
On top of that, there are often fees associated with opening and maintaining a HELOC. So check the details with any financial institution you’re thinking of using.
Lastly, HELOCs can give you access to a fairly sizeable amount of money. Be careful not to over-borrow and use more than you can afford to pay back. HELOCs are great tools to help pay for home renovations, college tuition, paying off high interest credit cards, and more. But use them wisely and know your limits so you don’t get into unnecessary debt.
What if Your Borrowing Circumstances Change?
Given the nature of a HELOC, lenders can change the terms of your line under certain unusual circumstances in order to protect themselves. If, for example, the value of your home drops significantly for some reason, or the lender has reason to believe you will no longer be able to make payments, they could lower your approved HELOC amount or freeze your account so you can’t borrow any more.
Is a HELOC Right for You?
If you’re looking to borrow money, it’s hard to find a more affordable source of funds than a HELOC, particularly since any interest you pay could be tax deductible. Check with your Financial Advisor for more information.
That said, before you apply for a HELOC, you should consider your overall level of debt, your risk tolerance, what you plan to do with the funds, and how much you need to borrow. A HELOC can offer a flexible, affordable way to achieve your goals, but be sure to assess if and how it fits into your overall financial situation.
What’s the Difference Between a Home Equity Line and a Home Equity Loan?
While a HELOC is a line of credit with a variable rate of interest that you draw against over time, a Home Equity Loan is a lump sum that you borrow and pay back in equal monthly installments with a fixed interest rate.
When interest rates rise and essentially make your HELOC more expensive to use, you may have the option of converting all or some of your balance to a fixed rate loan to save money and give you the peace-of-mind of a consistent, equal payment every month. Ask your lender about the options they offer and the benefits of each