Contributor, Benzinga
April 28, 2022

Is it time to change that wallpaper that’s straight from the 70s? Or do you wonder how you’re going to cover your child’s college expenses? 

If you’re a homeowner, a home equity line of credit (HELOC) could help. Let’s take a look at HELOC requirements for equity loans (or any type of line of credit.) You could potentially change the loan term, the principal balance, pull out cash and make the most of your primary residence with just one loan product.  

What is a HELOC (Home Equity Line of Credit)?

A HELOC is a line of credit that lenders offer. It’s based on the amount of equity in your home. It works a bit like a credit card in that you can borrow as little or as much as you want up to the credit limit. You only repay what you borrow, and you may be able to borrow more as you pay down your loan balance. 

A HELOC is different from a credit card in a couple of important ways:

  • It has 2 phases. HELOCs typically have 2 phases. You begin with a draw period (for example, a 10-year draw period.) This is when you can borrow from your credit line. In most cases, you’re only required to make low, interest-only payments during your draw period. After your draw period ends, you start your repayment period. The period of time you draw on the loan can differ, and some people even begin repaying earlier than expected. You’re no longer able to borrow against your credit line after the draw period closes, and you pay both principal and interest so your loan is paid off by the end of your repayment period.
  • It’s a 2nd mortgage. That means the HELOC is secured by your home. If a worst-case scenario happens and you’re unable to pay your HELOC, your lender can foreclose on your home. The outstanding balance is not rolled into your mortgage unless you refinance and use a combined loan to pay off both.

Remember, because this financial tool is like a credit card, it’s more flexible than a mortgage. Yes, it is a 2nd mortgage, but it can be much more than that. You can unlock quite a bit of potential and flexibility if you have equity in your home. If not, you may want to look into personal loans—Benzinga has tips and insights you might like to review.

HELOC Requirements

What do lenders look at when it comes to a HELOC? 

  • The value of your home and the balance of your mortgage. Lenders will typically allow you to borrow up to 85% of your home’s value less your mortgage balance. Using the previous example, 85% of the value of a $250,000 home is $212,500. Lenders would subtract the balance of your mortgage ($150,000) and leave $62,500. This means the maximum credit line you’re likely to be approved for is $62,500. These figures vary from lender to lender, and you should ask your loan officer what they can offer you because you don’t know unless you ask. Some borrowers are approved for more and some are approved for less.
  • The equity in your home. Equity is the value of your home less the balance of your mortgage. If your home is valued at $250,000 and you have a mortgage balance of $150,000 in your home, you have $100,000 in equity. Lenders typically want to see you have at least 15% equity in your home. For a $250,000 home, that would be $37,500 in equity. 
  • Your credit score. Lenders also look at how you’ve handled credit in the past. They use your credit score as an indicator. Your credit score is a computer-generated snapshot of your credit history. Making late payments, having accounts in collections and carrying high credit card balances lowers your score. In general, you’ll need at least a 620 credit score to qualify. As the banking industry changes after a massive run on the market, you might see changes in the qualifications lenders require. The higher your credit score, the lower your HELOC interest rate will be. Credit approval starts here. Plus, it can impact your upfront costs. You can check the minimum score accepted by several banks with Benzinga.
  • Your debt-to-income (DTI) ratio. Your DTI ratio is the amount of your monthly debt payments compared to your gross (pre-tax) income. Let’s say your car, mortgage, credit card payments and student loan payments total $1,500 per month. Your gross monthly income is $4,000 per month. That means you have a DTI ratio of 37.5% ($1,500 is 37.5% of $4,000). Lenders typically want to see a DTI of less than 43%. You can often get the lowest rate or a rate discount when you DTI is better than average.

Best Lenders for a HELOC

What’s the best mortgage company for a HELOC on your primary residence? Here are Benzinga’s picks.

When You Should Consider a HELOC

Since a HELOC is a flexible credit line, there are several scenarios where one might make sense.

  • Home renovations and repairs. Home updates can be expensive and unpredictable. A flexible credit line allows you to borrow what you need. When costs are higher than you expect, you can borrow more. 
  • Education expenses. Tuition, books and fees all add up, and the costs fluctuate each year. A HELOC can help manage those expenses. 
  • Big events: Weddings and other gatherings can be expensive, and the costs can be unpredictable. You also have to pay multiple vendors different amounts at different times. A flexible credit line can help manage the costs of a major purchase or around unexpected, major expenses.
  • Debt consolidation: If you have high-interest credit card debt, a HELOC can help consolidate the debt into one monthly payment with a lower interest rate. 

Cash-Out Refinance Loan Options

A HELOC isn’t the only way to access the equity in your home. If you don’t want to take out a 2nd mortgage, you may want to consider a cash-out refinance to gain access to funds so that you can use this extra money as quickly as possible. However, in this case, you’re not taking on another loan—you’re refinancing your current mortgage balance.

With a cash-out refinance, you replace your current mortgage with a new loan. Let’s say your home is valued at $200,000 and you owe $125,000 on your mortgage. Your home needs some updates. You talk to contractors, get estimates and decide you need $15,000. You get a cash-out refinance mortgage for $145,000, which covers the amount you owe on your mortgage, your repairs and $5,000 for closing costs.  

You receive your cash after closing in a lump sum. You can use the cash for whatever you need, whether it’s home repairs, educational expenses or debt consolidation. 

To qualify for a cash-out refinance, lenders look at:

  • Your credit score: As with a HELOC, you typically need a credit score of 620 or higher to qualify. 
  • Your DTI ratio: Lenders are looking for a DTI ratio of 50% or less. 
  • The amount of equity in your home: Depending on the type of mortgage and property values, you may be required to leave 15 to 20% equity in your home. That means you’ll need a fair amount of equity in your home to be able to cash anything out. 

Moreover, you shouldn’t take a cash-out refinance unless you have a plan to invest or use the money for financial gain. For example, you might use a cash-out refinance for:

  • Starting a business
  • Renovating the house
  • Investing in a rental property
  • Investing in a second home
  • Paying off college tuition

If you take out a large sum of money and do not know what to do with it yet, you may run into trouble because you have lots of cash burning a hole in your pocket—anyone would have the same trouble.

Cash-Out Refinance vs. HELOC

A cash-out refinance differs from a HELOC in a few ways: 

  • You only have 1 monthly payment. A HELOC is a 2nd mortgage with its own payment terms and schedule, and you need to keep up with your mortgage as well. 
  • You borrow a lump sum. With a cash-out refinance, you borrow all the money at once as a lump sum. With a HELOC, you have a flexible credit line that you can access throughout your draw period. 
  • Your interest rate can be fixed or variable. A cash-out refinance could have a fixed rate, which means the interest rate never changes, or it could have an adjustable rate, which means the lender can change the interest rate on a predetermined schedule. Most HELOCs have a variable interest rate. 

Which Option Is Right for You?

If you have equity in your home, either a cash-out refinance or a HELOC could be right for you. It all depends on your financial situation, which you qualify for and your personal preferences. 

One approach is to talk to lenders about both options. Talk to at least 2 to 3 online mortgage lenders or local banks. Let each know you’re looking for a home equity product and see which loan products are recommended for you. 

Another approach is to decide which product you prefer before you talk to lenders. If you like simplicity and you know how much money you need, a cash-out refinance could be the best bet. You end up with 1 monthly payment and a set sum of money. If you prefer flexibility and you don’t mind having a second mortgage, a HELOC could be the right way to go. 

Review any quotes you receive carefully. Look at the closing fees, the interest rates and the potential monthly payments. Make sure you’re clear about the terms of the product you’re considering. Choose a lender that offers competitive rates and excellent service. Plus, remember that you can refinance these loans in the future if you would like to improve your rates or terms.

Applying for a HELOC or Cash-Out Refinance

If you haven’t already, gather the documentation you’ll need to complete the formal application, including your W-2s, most recent tax returns, pay stubs and bank statements. In some cases, your lender will also order an appraisal of your home. Some lenders do an informal, drive-by appraisal. Others may want a formal process. 

Just like when you purchased your home, the process can take some time. Eventually, you’ll know whether you’ve been approved, and you’ll be able to close on your HELOC or refinance. Be patient, answer questions promptly and with time, you could have the cash you need. 

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