When you buy a home, it becomes an asset. You build up equity and stability, and HELOCs and mortgages are financial products related to homeownership that you should come to better understand in the future. Here’s more about what they are and how to put them to work for you.
What is a HELOC (Home Equity Line of Credit)?
A home equity line of credit (HELOC) is a financial product for homeowners that allows you to tap into the equity you hold in your home (or a related property). A HELOC allows you to borrow against the equity in your home.
So, what does that actually mean? Your home’s equity is the value of your home, less the amount you owe on your mortgage.
Let’s say your home is valued at $225,000. You owe $150,000 on your mortgage. That means you have $75,000 in equity. When you reach out to a bank or lender for a home equity line of credit, you should remember that you likely cannot borrow every dollar of the equity you currently hold, but you do have options.
How HELOCs Work
You can borrow against a percentage of the equity in your home with a HELOC. Most lenders limit the amount to 75% of your equity. If you have $75,000 in equity, you could be approved for a credit line of up to $63,750. However, you should ask your loan officer how much is available because you never know of the deals or options that certain lenders might make available.
You don’t receive the funds you borrow as a lump sum with a HELOC. Instead, lenders approve you for a credit line. It’s a bit like a credit card where you can borrow what you need, when you need it, up to the amount of your credit line. You only repay the amount that you borrow, plus interest.
HELOCs typically have 2 phases: a draw period and a repayment period. Your draw period is when you can borrow against your credit line. Once you borrow money, you may be able to make minimum, interest-only payments, but this varies by lender. The length of your draw period also varies by lender.
Once your draw period ends, you enter repayment and you can no longer borrow against your credit line. You have a set amount of time to repay what you borrow. The length of your repayment period also varies by lender. For example, you might have a 30-year HELOC with a 10-year draw period and a 20-year repayment period.
HELOC Pros and Cons
Let’s look at the pros and cons of a HELOC.
Pros
- Flexibility: While you’re approved for a set limit, you can borrow as much or as little as you need. You can borrow again as you pay down your line of credit. Most of life’s expenses aren’t fixed, so the flexibility of a HELOC is a big advantage.
- Low payments: Depending on the terms of the lender, you may be able to just pay the interest on what you borrow during your draw period. Having low payments can be an advantage when it comes to budgeting and managing other expenses.
- Refinancing: You can refinance a HELOC if you want. Plus, you can roll your HELOC into your mortgage or obtain a new mortgage that includes the value of the HELOC, thus reducing your payments and removing the pressure of paying off the HELOC on-time.
Cons
- Potential risk to your home: HELOCs are secured by your home. That means that if you don’t keep up with the required payments, you could lose your home. It’s important to keep this in mind when you consider a HELOC. Only borrow as much as you can afford to repay.
- Fees: Lenders charge fees for obtaining a HELOC. These also vary by lender, but you’ll typically pay at least an application fee. You may also need to pay for an appraisal, title search and other fees. Check the rules for your state because certain jurisdictions do not allow lenders to charge fees or require early repayment penalties.
Best Lenders for a HELOC
What’s the best mortgage company for a HELOC? Here are Benzinga’s picks.
- Best For:Flexible Mortgage Optionssecurely through Angel Oak Mortgage Solutions's website
Available in: CA, CO, CT, DC, FL, GA, IL, MD, MA, MI, NH, NJ, NY, NC, OH, PA, RI, SC, TN, TX, VA, WA
What is a Mortgage?
A mortgage is a loan used to buy a house. It’s a secured loan, which means that if you’re unable to keep up with your mortgage payments, your lender can foreclose on the home. That means that the lender takes back the home and sells it to pay the balance of your mortgage. You may also choose to submit the deed in-lieu of foreclosure to the lender, whereby they can sell off the house to recover their losses and you can walk away without fully foreclosing on the house.
Yes, a deed in-lieu of foreclosure goes on your credit report, but it is not as damaging, and it indicates that you communicated with the lender instead of walking away from the house without attempting to work out a resolution for your situation.
How Mortgages Work
You apply with one or more lenders with a mortgage. You can start by getting preapproved, which means that a lender reviews your income, credit and assets and thinks it’s likely that you’ll be approved for a mortgage. Getting preapproved strengthens your offers when you bid on a home. It also gives you a sense of how much you can borrow.
Once you put an offer in on a home and it’s accepted, you’ll complete your formal application for a mortgage. The lender will make a decision about whether to approve you for the mortgage.
With most mortgages, you’ll need to make a down payment. You’ll need to meet the minimum down payment requirements of your lender, but you can make a larger down payment, which lowers your monthly mortgage payments. VA loans and USDA loans typically don’t require a down payment.
Mortgages vs. HELOCs
Mortgages are used to buy or refinance a home. Refinancing means replacing your current mortgage with a new one. The new mortgage might have a lower interest rate or different terms like a shorter or longer repayment period. A refinance mortgage can also be used to borrow against your home equity.
If your home is worth $225,000 and you owe $150,000, you could refinance for $175,000, which would give you $25,000 in cash at closing. You still just have 1 mortgage — you’ve just replaced the old one with a new that has a higher balance.
A HELOC is also a mortgage, though it’s a second mortgage.
Since your HELOC is a second mortgage, you have to make payments on both your primary mortgage — the one you used to buy or refinance your home — and on your HELOC. HELOCs have a lot of flexibility, but they can’t be used to buy or refinance a home and help you access equity.
Mortgage Pros and Cons
What are the pros and cons of a mortgage? Let’s take a look.
Pros
- Low interest rates: Mortgages typically have low interest rates, especially when compared to other financial products like credit cards.
- Equity: Building up equity means that you have an asset you can borrow against if you need to. It also means that when you sell your home, you may come out ahead on the transaction, depending on the housing market over time. If you pay on your mortgage long enough, you’ll eventually own your home outright.
- Refinancing: You can refinance a HELOC just like you would a mortgage. You can even roll it into your mortgage in the future to save money, lower the payments or avoid issues with repayment.
Cons
- Complexity: Some mortgage products are straightforward. Fixed-rate mortgages have the same interest rate and the same monthly payment on your principal and interest for as long as you have your mortgage. Some are more complicated. Adjustable-rate mortgages have an interest rate that the lender can change, which also changes your monthly payments. As you consider your mortgage options, make sure you’re comfortable with the type of mortgage you choose.
- Fees: Mortgages come with expenses. In addition to the interest you pay, mortgages also have closing costs. These costs either need to be paid at closing or rolled into your mortgage, which means you have to borrow more. Closing costs may include application fees, title fees, escrow fees and more.
- Using the incorrect financing: You may simply need a personal loan instead of getting your house and mortgage involved in a HELOC. Carefully consider your options before continuing.
Best Mortgage Lenders
To find the best mortgage rate and terms, contact multiple lenders. Here are Benzinga’s picks for the best ones.
Choosing the Right Lender
Whether you’re applying for a mortgage or a HELOC, you need to choose the right lender. What should you look for?
- Service that makes sense for you. Some borrowers prefer an online mortgage experience with minimal face-to-face interactions. Others prefer a loan officer they can talk to in person. You’ll find great lenders in both categories — it just depends on what you prefer.
- Your preferred loan options. If you know you’re applying for a VA loan, look for a lender that specializes in those loans. Ask lenders what options they offer to confirm they have the right one for you.
- An educational focus. Good lenders want you to understand how your mortgage or HELOC works. They’ll answer your questions promptly and patiently, and they may have educational resources like articles and calculators on their website. If you get a sense that your lender wants to rush through the process or push you into a particular type of loan, steer clear.
Contact at least 2 to 3 lenders to compare rates and terms. Look at the fees and terms of each quote, and don’t feel obligated to use the full amount you’re approved for. Your budget should drive how much you borrow, whether it’s a mortgage or a HELOC. Take your time, review the numbers and you’ll find the right product to move you toward your financial goals.
Frequently Asked Questions
Can you pay off a mortgage with a HELOC?
While it is possible to use a HELOC to pay off a mortgage, it may not always be financially beneficial. It is important to carefully consider the interest rates, fees, and terms of both the HELOC and the mortgage before making a decision.
What happens if you can't repay a HELOC or mortgage?
If you are unable to repay a HELOC or mortgage, there are potential consequences, including foreclosure or other legal actions. It is important to prioritize timely and full repayment of these loans.
How do you choose between a HELOC and a mortgage?
The choice between a HELOC and a mortgage depends on factors such as the purpose of the loan, the interest rates, fees, and terms, and your individual financial situation. It is recommended to consult with a financial advisor or mortgage professional to determine the best option for your specific needs.
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