Home Equity Line of Credit (HELOC)
After you purchase a home, you start to build equity over time. You can use the equity that you have built up to get a home equity line of credit, or a HELOC. A HELOC is a line of credit secured buy your home that gives you a revolving line of credit to use for large expenses or to consolidate high-interest rate debt. A HELOC is best for homeowners who need access to funds over several years specifically for home improvement projects who are comfortable using their home as collateral. A HELOC often has a lower interest rate than other traditional loans and the interest may be tax deductible.
How Does a HELOC Work?
A HELOC uses the equity (the difference between your home’s value and your mortgage balance) built up in your home as collateral. HELOC loans offer competitive interest rates which are appealing to current homeowners who need some extra cash for renovations or to pay off debt.
A HELOC is given to the borrower as a form of a credit card and gives them access to a credit line that you can draw from and pay back as needed. A HELOC is available for a set time frame, usually up to 10 years. When the line of credit time period ends, borrowers will enter the repayment period which can last up to 20 years. You will only pay back the outstanding balance that you borrowed as well as any interest owed.
How Does a HELOC Affect My Credit Score?
Since a HELOC loan is a revolving line of credit, it can impact your credit both negatively and positively. When you first apply for a HELOC, your lender will pull your credit to get a look at your current financial situation which may cause your score to drop a few points. A HELOC loan will only hurt your credit significantly if you fail to make payments or if you miss payments altogether.
Advantages to a HELOC
- Lower upfront costs that traditional home equity loans
- Lower interest rates than with a credit card
- Low or no closing costs
- Interest is only charged on the amount that you owe
Disadvantages to a HELOC
- Home equity lenders place a second lien on your home, giving them rights to your home along with the first mortgage lien if you stop making payments. A lien is a claim or legal right against assets that are typically used as collateral to satisfy a debt
- The more you borrow against your home, the more you are putting yourself at risk
- Interest rates may go up or down
- Lenders may charge a variety of fees
- Late or missed payments can damage your credit and put your home at risk
How Much Can I Borrow With a HELOC?
Lenders underwrite a HELOC the same way they do with any traditional loan. All lenders and banks have different guidelines that decide how much they can lend based on the value of your property and your credit score. The amount a lender is willing to lend to a customer is expressed in a combined loan-to-value (CLVT) ratio. This ratio measures the value of all the loans that secure the home, including the first and second mortgage, against what the home is currently worth. Ultimately, the amount of money you can borrow with a HELOC is determined by the amount of equity you have in your home.
Can You Pay Off a HELOC Early?
This will depend on your lender and whether there is a penalty to paying off your loan early. Some lenders do charge prepayment penalties that could cost a few hundred dollars.
How to Apply for a HELOC
Like any other loan type, borrowers can apply for a HELOC directly through their lender which should only take a few minutes. Start with these steps to make the application process as smooth as possible.
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Check your credit score
The higher your credit score, the better the rates and more likely you are to get approved.
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Shop Around
Shop around to make sure you are getting the best rate and terms possible.
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Gather Documents
Gather all application materials and have all documents ready for your lender.
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Verify
Complete the verification process which include pay stubs and tax returns.