Is a HELOC the right financial move for you?
If you’re facing big, ongoing expenses like home renovations or college tuition, a home equity line of credit (HELOC) could be a solid option for you.
HELOCs offer the flexibility to draw cash as you need it, rather than taking out a lump sum, and you only pay interest on what you borrow.
Plus, they allow you to tap into your home’s value without going through the hassle of refinancing your primary mortgage. Just keep in mind that your home serves as collateral, so it’s essential to manage the loan responsibly.Check your HELOC options. Start here
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What is a HELOC?
A home equity line of credit, or HELOC, is like a credit card that’s backed by the value of your home.
Think of it as a financial safety net that allows you to tap into your home’s equity whenever you need extra cash—be it for home improvements, emergency expenses, or other big-ticket items.
During the initial phase, you can borrow money up to a certain limit and only pay interest on the amount you’ve borrowed. It provides flexibility and easy access to funds without the need to refinance your existing mortgage, but keep in mind that your home is the collateral, so borrow wisely.
How do HELOCs work?
A HELOC is a revolving line of credit that can be borrowed against and repaid as needed. It’s a type of loan that allows you to borrow money against the equity in your home.Check your HELOC options. Start here
Here’s how a HELOC works:
- You apply for a HELOC. You’ll need to fill out an application with a lender and provide information about your income, credit score, and the value of your home
- Your lender determines your credit limit. Your lender will review your application and determine how much you can borrow based on your credit score, income, and the equity in your home
- You can access funds as needed. Once you’re approved, you can access funds from your HELOC as needed, up to your credit limit. You can withdraw funds using a check, credit card, or electronic transfer
- You pay interest on the amount you borrow. You’ll only pay interest on the amount you borrow from your HELOC, not the entire credit limit. The interest rate may be variable or fixed and may be based on the prime rate or another benchmark rate
- You make monthly payments. You’ll need to make monthly payments on your HELOC, including principal and interest. The length of the repayment period may vary, but is typically between 10 and 20 years
- You can use the funds for any purpose. Unlike a traditional mortgage, you can use the funds from your HELOC for any purpose, such as home improvements, debt consolidation, or to pay for education expenses
It’s important to keep in mind that if you are unable to make loan payments on a HELOC, your lender may foreclose on your home. Additionally, taking out a HELOC can be risky if you’re unable to make payments or if the value of your home decreases, as you could end up owing more than your home is worth.
Why are HELOCs so popular these days?
The rise in popularity of HELOCs can be attributed to a change in the financial landscape. While the pandemic caused historically low mortgage rates, making cash-out refinancing an appealing option, rates have risen in 2023.Find your lowest HELOC rate. Start here
Because the majority of homeowners have already secured lower rates and do not want to disrupt those by refinancing at the current higher rates. This makes cash-out refinancing less appealing as an option to access home equity.
HELOCs offer a more flexible alternative, allowing homeowners to tap into their home’s equity without affecting their first mortgage rate.
Data underscores this trend: The number of HELOC originations rose by 10.7% between 2020 and 2021, according to Home Mortgage Disclosure Act data. Given these factors, it is easy to see why HELOCs have emerged as a popular option for homeowners in 2023.
How much can I borrow with a HELOC?
The amount you can borrow with a HELOC largely depends on the value of your home and your existing mortgage balance.
Generally, lenders look at what’s called the combined loan-to-value ratio (CLTV), which often ranges between 80% and 90%. Your CLTV is basically how much you owe on your home relative to its current value.
For example, if your home is worth $400,000 and you still owe $200,000 on your mortgage, your CLTV would be 50% ($200,000 divided by $400,000).
To figure out how much you can borrow with a HELOC, you can follow these steps:
- Find out the current market value of your home.
- Determine the loan-to-value ratio that the lender is willing to offer. This is usually a percentage, like 80%.
- Multiply the market value of your home by the LTV percentage. This will give you the maximum amount the lender is willing to let you borrow against your home.
- Subtract any amount you still owe on your mortgage from this number.
- The result will be the maximum amount you can borrow using a HELOC.
For instance, if the lender offers an 80% LTV and your home is worth $400,000, you would first multiply $400,000 by 0.80, which is $320,000. If you still owe $200,000 on your mortgage, you’d subtract that from $320,000, leaving you with a maximum HELOC amount of $120,000.
Keep in mind that just because you can borrow up to a certain amount doesn’t mean you should. Always consider your ability to repay the loan and how it fits into your overall financial plan.
How does HELOC repayment work?
Repaying a HELOC is a bit different from repaying a traditional loan. A HELOC has two main phases: the draw period and the repayment period. Here’s how each works:
- The draw period: Often lasts for 10 years, during which you are allowed to borrow from the credit line at any time up to your credit limit. During the draw phase, you are only obligated to make interest payments on the money borrowed. If you borrow no money, you typically owe nothing.
- The repayment period: Next comes the repayment period, a 10- to 20-year phase during which you’ll need to repay your loan balance. You are not permitted to borrow additional funds during this time unless the lender approves the renewal of your HELOC
Note that some HELOCs require you to repay the entire balance in full as soon as the repayment period begins. Some borrowers can convert their HELOC to a fully amortizing fixed-rate second mortgage during the loan’s term if their lender allows it. Ask your lender about its repayment structure before signing on.
Current HELOC rates
As you might suspect, home equity line of credit rates vary widely by lender and product type. Just like mortgage rates on a traditional mortgage, your HELOC rate will also depend on factors such as your credit score, debt levels, and the amount you request to borrow.
To ensure you don’t miss out on the best HELOC rates, compare quotes from various lenders when shopping around. Look for the lowest rate and the best combination of interest rate and upfront fees.
HELOC pros and cons
As with any type of financing, a HELOC has both benefits and drawbacks. It’s important to understand how a HELOC can help you and the potential risks before obtaining this type of loan.Check your HELOC options. Start here
|HELOC Pros||HELOC Cons|
|Borrow up to 85% of home value*||HELOC rates are higher than mortgage rates|
|Money can be used for any purpose||Charges closing costs|
|Offers a flexible credit line for ongoing expenses||Possibility of overspending|
|Tax-deductible in some casesLower interest rates than credit cards||Your home is used as collateralVariable interest rates|
*Maximum loan amounts vary by lender and depend on borrower eligibility.
Pros of a HELOC
Most lenders that offer home equity lines of credit will allow you to borrow up to 85% of your home’s appraised value. In other words, you can enjoy a fairly high borrowing limit if you qualify.
So long as you’ve accrued enough equity in your home (more than 15% to 20%) and have good credit, you will likely be eligible for a HELOC, too. Here are some of the notable benefits of a HELOC.Check your HELOC options. Start here
1. Low interest rates
HELOCs generally offer lower interest rates than home equity loans, personal loans, and credit cards. Getting a lower HELOC rate can save you thousands of dollars over the life of your loan.
2. Flexible financing
One of the biggest advantages of a HELOC is that you can use the funds for virtually any purpose. A HELOC can be useful to finance home improvements, cover medical costs, consolidate debt consolidation, or cover any other expense in line with your personal financial situation.
“HELOCs are arguably more flexible than a traditional cash-out refinance of your home loan... you can access a line of credit as needed, as opposed to having cash from a refi sitting in a savings account.”
—David Friedman, CEO, Knox Financial
“HELOCs are arguably more flexible than a traditional cash-out refinance of your home loan. Once approved for a HELOC, you can access a line of credit as needed, as opposed to having cash from a refi sitting in a savings account,” notes David Friedman, CEO of investment property platform Knox Financial. “With a cash-out refi, you are committed to paying the new principal and interest balance for the duration of the home loan — likely 15 to 30 years.”
3. Borrow only what you need
Another HELOC benefit is the ability to only borrow the money that you need. You can borrow as much as you like during the draw period, pay down the loan balance, and then borrow again.
In this way, HELOCs are similar to credit cards. Cash-out refinancing, personal loans, and home equity loans all require you to borrow one lump sum of money.
“Your available credit is restored whenever you pay down your outstanding HELOC balance,” explains Dino DiNenna, broker/Realtor with Southern Lifestyle Properties in South Carolina. “This implies that you can borrow against your HELOC again and again if necessary and that you can borrow up to the credit limit you set at closing for the duration of your draw period.”
Note that some HELOCs impose an early payoff fee if you pay off the balance before a certain amount of time has passed. Ask your lender about its prepayment policies before taking out the loan.
4. Interest may be tax deductible
You might also be eligible for a tax break if you use a HELOC to buy or renovate a home.
“Any interest paid on a HELOC or home equity loan that is used to purchase, construct, or enhance the property that serves as security for the loan is tax-deductible,” says Sep Niakan, managing broker for CondoBlackBook.com.
Cons of a HELOC
Although HELOCs allow you to tap your home’s equity, there are considerable disadvantages to this type of loan. It’s important to understand a HELOC’s risks before choosing one.Find your lowest HELOC rate. Start here
Your home is collateral
Perhaps the biggest drawback to a HELOC is that you must use your home as collateral. That means you could lose your home to foreclosure if you cannot repay your HELOC per the agreed-upon terms.
Variable interest rates
While home equity loans offer fixed interest rates that will not change, HELOC rates are variable. This means that the rates rise and fall with the broader rate market. So even though your HELOC had a lower interest rate when you first took out the loan, the rates will increase (or decrease) over time.
Additionally, HELOC interest rates can be higher than rates for a traditional mortgage loan, including a cash-out refinance. At the time of this writing in March 2023, the average interest rate charged for a HELOC was around 7.8%, compared to around 6.7% for a cash-out refinance.
Risk of overspending
Some homeowners risk overspending with a HELOC, especially if they’re awarded a generous credit limit.
“A borrower’s lack of discipline is frequently a drawback of HELOCs,” cautions Shad Elia, CEO and founder of New England Home Buyers in Massachusetts.
“It’s simple to access cash quickly without thinking about the possible financial consequences because HELOCs allow you to make interest-only payments during the draw period.”
–Shad Elia, CEO/founder, New England Home Buyers
Elia continues, “Remember that the loan eventually starts to amortize, and the payments dramatically increase if you do not refill this line of credit by paying it off. The increase in monthly payments at the end of the draw period may be an unpleasant surprise if you aren’t prepared for it.”
Lastly, consider that you may pay closing costs on a HELOC ranging from 2% to 5% of the line of credit. Although some lenders are willing to waive closing costs.
When is a HELOC a good idea?
A HELOC is a good idea when you’re making home renovations that will increase the market value of your home.
A HELOC provides an affordable credit line to finance ongoing expenses, with much lower rates than other forms of borrowing like credit cards and personal loans. In addition, you’re allowed to use the funds for any purpose, such as student loans, credit card debt, or real estate investments. But the best use of a HELOC is to increase your home’s value.
However, remember that if you get in over your head by overborrowing, you risk losing your home. HELOCs are secured by the property, and failure to make payments can lead to foreclosure. By contrast, personal loans and credit cards have higher interest rates but are not tied to your home. They are less risky in the event of a default.
Do I qualify for a HELOC?
HELOC requirements can vary depending on the lender, so it’s a good idea to shop around and compare offers from different lenders before making a decision.
But there are some common prerequisites you’ll generally need to meet, like having a decent credit score, a stable income, and a certain amount of home equity.
Most lenders also look at your debt-to-income ratio to make sure you can handle the additional loan payments on top of your existing financial obligations. So, before jumping in, it’s wise to check these factors and possibly consult with financial advisors to make sure a HELOC is the right fit for you.Check your HELOC options. Start here
Here are some common HELOC requirements:
- To be eligible for a HELOC, you’ll usually need at least 15-20% equity in your home and a credit score above 620 for more favorable rates
- Lenders look for a steady income, potentially from multiple sources like employment, investments, or rental properties. They’ll also consider your debt-to-income ratio to assess your ability to manage the loan
- An appraisal might be required to confirm your home’s value, along with a title search to ensure no existing liens could complicate the loan
Additionally, lenders will want documentation that proves you can make monthly payments and may also require proof of homeowner’s insurance to guard against property damage.
Are there any alternatives to a HELOC?
Home equity lines of credit can be useful for the right type of borrower. But many homeowners may want to consider other financing solutions.Check your HELOC options. Start here
- Home equity loan: A home equity loan helps you leverage the equity in your home. The loan amount is issued in a lump sum and repaid in monthly installments. Both the interest rate and monthly payments are fixed. But your home is used as collateral to secure the loan
- Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new, larger loan. You receive the cash difference between the new loan balance and your old mortgage balance as a lump sum. However, your entire mortgage is reset
- Personal loan: This is an unsecured loan from a bank, credit union, or online lender that you pay back in fixed monthly payments. Because your home is not used as collateral for the loan, you will pay a higher interest rate
Regardless of the loan option you choose, be sure to compare rates and costs with several lenders to ensure you’re getting the best deal.
FAQ: Is a HELOC a good idea?
Using a HELOC as a down payment on a second property is risky but allowed. Not only will you have two mortgage payments, but you’ll also have to repay the HELOC at the same time. However, if you have the cash flow, then a HELOC can be a down payment option for a second home or real estate investment.
Homeowners must qualify for a HELOC based on sufficient income, job security, good credit, and a positive financial history. You must have built up more than 15–20 percent equity in your home to have enough to fund a HELOC. If you don’t have that much home equity yet, then you may not be eligible for a HELOC. This is often the case with first-time buyers and recent purchasers.
You are not required to draw funds from a HELOC during the draw period. However, your lender may charge you an inactivity fee if you incur no transactions over a particular period. Most lenders will allow a HELOC to remain open indefinitely if it has not been used. Still, some lenders may have a clause requiring some activity to prevent the HELOC from being closed.
In a market crash, your HELOC would remain open with the funds available, unless there is language in your agreement that says otherwise.
A HELOC cannot trigger PMI (private mortgage insurance), which is assessed only on your primary mortgage if your lender or loan program requires it. Even if your HELOC is the only loan you currently have against your home and you have a loan-to-value balance over 80 percent, it will not require PMI. Note that you cannot use the funds from a HELOC to pay off your primary first mortgage in order to get rid of PMI.
Yes. You can pay off the principal owed on a HELOC at any time during the draw period, either partially or in full. Although some lenders may impose an early payoff fee if you start paying off the balance before a certain amount of time has passed. During the draw period, you must at least make interest payments on anything you borrow. Once you enter the HELOC’s repayment period, you will be required to pay off your balance in full immediately or over time.
If you have a HELOC open, you can sell your home and use the sale proceeds to pay off the HELOC balance at closing.
You may already qualify for a HELOC
Many homeowners have built equity quickly due to rising home prices. If this is your situation, then you may easily qualify for a HELOC.
Get a few quotes from different lenders. They’ll each review your personal finances and determine how much money you can borrow. You can get started with the link below.Time to make a move? Let us find the right mortgage for you