Thinking of renovating your home? Or do you need some additional college funds? If you’ve owned your home for a bit, you can tap into its equity.
Is a HELOC (home equity line of credit) a good idea? Let’s take a look.
What Is a HELOC?
A home equity line of credit (HELOC) is a credit line extended to you by a lender. Lenders base your credit line on the amount of equity you have in your home, and your credit line is secured by your home. So what does all that mean?
Let’s start with equity. Your home’s equity is what you have when you take the value of your home and subtract your mortgage balance. Let’s say you have a home that’s valued at $200,000. You owe $125,000 on your mortgage. That means you have $75,000 of equity in your home ($200,000 – $125,000 = $75,000).
With a HELOC, a lender offers you a line of credit. A line of credit is similar to a credit card. It has a maximum amount based on a percentage of equity in your home. Lenders typically limit HELOCs to 85% of your equity. If you have $75,000 in equity, 85% of your equity is $63,750.
Generally, you can borrow as much as you need up to the maximum. As you repay the credit line, you may be able to borrow more depending on your lender’s terms. At times, the HELOC can work more like a credit card, with the lender going so far as issuing you a debit card you can use to draw on the account.
Let’s say you’re approved for a $60,000 line of credit. You borrow $30,000 for home renovations right away. A few months down the road, you realize that you might as well add on that workshop you’ve always wanted. You borrow another $10,000. You’re still well under your credit line, so it’s no problem. You have plenty of time to draw on the account, but you will still need to make payments.
How HELOCs Are Structured
HELOCs vary by lender, so review the terms of any offer carefully. In general, HELOCs have 2 periods: a draw period and a repayment period.
During your draw period, you can borrow money. You’ll also be required to make payments on what you borrow. Draw periods typically last 10 years. After that, you must be aware of how the HELOC changes, if you need to refinance, change the terms or simply begin paying off the loan.
At the end of your draw period, you enter your repayment period. Once you enter repayment, you can no longer borrow against your line of credit. You’ll make regular payments until your line of credit is repaid. Repayment periods typically last 20 years. Remember, some states allow the lender to charge early repayment penalties, but others do not. Understand what you’re getting into before making this critical choice.
Some HELOCs require you to repay the entire balance at the end of the draw period. That means you owe a large payment, which is sometimes referred to as a balloon payment. Make sure you know the repayment terms of any HELOC you’re considering.
Qualifying for a HELOC
To qualify for a HELOC, you must have equity in your home. Lenders will also look at your credit score and history, income and debts to make sure you can repay the loan.
HELOC Fees and Interest
HELOC fees also vary by lender. Some charge origination fees, early termination fees and closing costs. Some may not. Fees are another aspect to consider when you’re choosing a HELOC lender.
HELOCs typically have variable interest rates. That means the lender can increase or decrease your interest rate. With a HELOC, the interest rate can change from month to month much like a credit card with a variable rate. Lenders typically base the interest rate on an index (like the U.S. Prime Rate) and a margin — a percentage that’s added to the index. The margin stays the same, but the index rate changes. As the index rate increases or decreases, your interest rate changes as well.
Let’s say your margin rate is 2% and the index rate is 4%, so your total interest rate is 6%. The next month, the index rate drops to 3.75%. That means your total interest rate for that month is 5.75%.
What You Can Use HELOC For
There are no restrictions on what you can use a HELOC for. Some common reasons for taking out a HELOC include:
- Home improvements
- Education expenses
- Medical expenses
- Debt consolidation
- Emergency expenses
- Big events
You don’t have to know what you’re going to use the HELOC for when you apply. However, it helps to have a plan for how you will use the money.
Here are a few reasons why you might want to apply for a HELOC:
- Flexibility: With a HELOC, you can borrow what you need, when you need it. A lot of life’s expenses are unpredictable, so having a flexible line of credit can come in handy. Some lenders also offer some flexibility with repayment, so you may have a low introductory rate or you may be able to make interest-only repayments during your draw period.
- Easy access to funds: Depending on the lender, you may be able to write checks against or credit line or you may have a credit or debit card to access your funds. You don’t have to wait for your lender to issue you a check, and then for the check to clear.
- No restrictions: You can use the money for what you need to with no restrictions. You can even use it for multiple purposes, like paying for college tuition and making some repairs to your home.
- Refinancing: You can refinance your HELOC to roll it into your mortgage, get a better rate or find better terms.
Here are a few drawbacks to consider when it comes to HELOCs:
- Your home is collateral: A HELOC is like a mortgage. If you’re unable to make payments, the lender can foreclose on your home. Make sure that you understand the payment schedule and that you can repay what you borrow.
- Confusing payment schedules: HELOCs are a complex financial product. Don’t hesitate to ask questions to make sure you understand what you’re signing up for. For example, will your interest rate change, or will it stay the same? Do your payments include both principal and interest? If you make minimum payments, will your loan be paid off or will you owe a big payment at the end? The best mortgage company for a HELOC is 1 that provides clear answers to your questions.
Best Mortgage Lenders for a HELOC
Which lender is best when it comes to a HELOC? Here are Benzinga’s top picks.
*Home Equity Line advertised rate of 3.49% includes a 0.75% discount for opting into a Quorum Membership (0.50%) and enrolling in autopay (0.25%). This rate also includes payment of an origination fee of 4.99%, for those who qualify.
Home Equity Loan
Another product you might come across in your search for a HELOC is a home equity loan. While they might sound similar, these products work differently.
With a home equity loan, you borrow a lump sum of money based on the equity in your home. As with a HELOC, the maximum you can typically borrow is 85% of your equity. Unlike a HELOC, you borrow the entire amount you need upfront and then start repaying it immediately. Again, you should have a plan for how to use this money so that you are not caught up making poor financial decisions at the last second.
You usually have a long time to repay a home equity loan — usually 20 or 30 years. These loans also tend to have a fixed interest rate, so your payments are predictable. HELOCs have a variable interest rate, which means your monthly payment can change.
Home equity loans are also similar to HELOCs in that your home serves as security for the loan. If you’re unable to repay your home equity loan, the lender has the right to foreclose on your home.
Find the Right HELOC
Is a HELOC right for you? And what should you look for in a HELOC?
A HELOC might be right for you if you prefer a flexible credit line. Sometimes you have a big expense, but you don’t know exactly how much that expense will be. Home renovation costs can be unpredictable. Your child might transfer to a more expensive college.
It might also be right for you if you don’t mind variable costs. Most HELOCs have interest rates that the lender can change, also known as variable rates. That means your required payments can increase or decrease.
Some readers might need a personal loan instead, one that is much less complicated. To learn more, you can check out Benzinga’s information on personal loan products.
To find the right HELOC, decide what’s important to you. Are you comfortable with an online mortgage lender or do you prefer in-person service? Do you want to work with a local bank or credit union,or do you prefer the resources of a national lender?
As you narrow down your options, review the terms of potential HELOCs carefully. Look for the annual percentage rate (APR), which includes loan costs. Review the repayment schedule and make sure you’re comfortable with it. Contact multiple lenders so you can find the best HELOC.
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