What Are Home Equity Lines of Credit?
A Home Equity Line of Credit, or HELOC, is a financial tool that allows homeowners to tap into the equity they’ve built in their homes. It functions much like a credit card but is secured by the value of your home. Here’s a closer look at what a HELOC is and how it operates.
When you have a HELOC, you essentially have access to a revolving line of credit, just like a credit card. This line of credit is secured by your home’s equity, which is the difference between your home’s current market value and the outstanding balance on your mortgage. Most lenders offer HELOCs with variable interest rates, which means the interest rate can change over time.
Repayment terms with home equity lines also vary. When it comes to a HELOC, there’s a draw period, usually spanning a decade, during which you can utilize the funds. During this period, your obligations typically involve paying only the interest on the withdrawn amount. Following this phase, you transition into the repayment period. In certain home equity line arrangements, this entails making monthly payments for the subsequent 20 years, while in others, it might involve a balloon payment to settle the entire borrowed sum all at once.
Is it Good to Take Out a Home Equity Line of Credit?
According to the Wall Street Journal, “In general, a 2nd mortgage or home equity line is a suitable option for individuals who are employed full-time, have steady income, can manage the extra monthly payments, and possess a credit score of 640 or higher,.” The WSJ suggests that paying off higher-interest debt with a home equity line can also solidify the qualification.
Key Features of Home Equity Lines:
Revolving Credit: Home equity lines allows you to borrow funds, repay them, and borrow again. This flexibility is one of the primary advantages of a HELOC.
Variable Interest Rate: Most HELOCs have variable interest rates, meaning your payments can fluctuate based on market conditions.
Secured by Your Home: Your home serves as collateral for the HELOC, which means if you don’t repay the borrowed amount, your home could be at risk.
Draw Period: HELOCs typically have a draw period, during which you can access funds, usually ranging from 5 to 10 years.
Repayment Period: After the draw period ends, you enter the repayment period, during which you start paying back the borrowed amount, plus interest. Repayment periods can last up to 20 years.
Common Uses for a Home Equity Lines:
Home Improvements: Many homeowners use HELOCs to fund renovations or upgrades that can increase their home’s value. Compare HELOCs to Construction Loans.
Bill Consolidation: Some use a HELOC to pay off high-interest debts like credit cards, as the interest on a HELOC is often lower.
Emergency Expenses: A HELOC can provide a financial safety net for unexpected expenses like medical bills or major car repairs.
Education: Financing a child’s education or your own can be more affordable with a home equity line compared to other types of loans.
Home equity lines are a versatile financial tool that allows homeowners to access funds using their home’s equity as collateral. It offers flexibility, but it’s important to be aware of the potential risks and responsibilities associated with a HELOC.
Learn How to Leverage Hour House with Home Equity Lines of Credit that Provide Quick Access to Cash at an Affordable Interest Rate.
Once you apply for an equity line of credit and are approved, the lender will give you either a check book or a debit card and you take the money out as it is needed. You will only pay interest on what you take out, and you are limited only by the total credit line you are given.
Home Equity Lines Are the Most Popular Way that Homeowners Are Tapping Their Equity.
People who own their home today are most likely enjoying an increase in their equity position. Home prices are going up and homes are appreciating in value. This increases the equity that a home owner has in the home. It also means that the owner can pull some of that equity out of the property and do some remodeling.
One of the most popular instruments used today to do home remodels is a home equity line or credit, or HELOC. The home equity line is a 2nd mortgage that you get while leaving the first mortgage in place. An equity line of credit is used to take equity out of the home up to a certain amount; the maximum amount varies by lender and by state. Some situations allow the home owner to pull up to 80% of the home’s value out, while others may allow 85% or 90%.
The home equity credit line is a variable interest line of credit based upon the amount of equity in the home. The home equity line lender will give you a HELOC with a certain line of credit, such as $25,000. You can draw that money out of the property whenever you wish, either in small increments or all at once.
HELOCs are a great way to access your home’s equity for things that you need in your life. Here are some of the big advantages of home equity credit lines:
#1 Low Initial Interest Rate
Home equity lines have an initial draw period where you have a low interest rate and you are paying interest only on the loan. In most cases, the home equity line of credit rates are considered low when coming it to conventional mortgage rates. Note that the interest rate on home equity lines are variable and it could possibly rise. The initial rate on a equity line is often quite low as it may be an introductory period rate, but it can rise in the future. After shopping credit line rates, check today’s home equity loan rates so you can compare the two options in a side by side analysis.
#2 You Have Years to Draw the Money Out
One of the big benefits of a HELOC is that you only need to take money out and pay interest on it as you need it. So you are not paying interest on money that is just sitting in your bank account for several months. A home equity credit line is a good choice for a use or project that you need to fund over time. Most of the time homeowners appreciate the fact that with a home equity line of credit, the minimum payment is interest only. This is great for cash flow, but at some point, borrowers will need to start paying the home equity line of credit back.
A popular use of a home equity line of credit is to fund a college education. You will need to make tuition payments over several years. You will be able to pull the money out of your home over 5-10 years, whatever the draw period is on your credit line.
#3 Interest Is Tax Deductible
Most homeowners are able to take advantage of the mortgage interest tax deduction, and write off the interest on their 2nd mortgages. This home equity tax deduction is very popular and it should be because it saves people hundreds or thousands on their tax bill every year. Interest paid on most other types of loans is not tax deductible as for 2023 unless you are making home improvements. Stay tuned for updates.
#4 Interest Rate Is Lower Than Other Loans
In most cases, a home equity credit line rate will have a higher interest rate than your first mortgage, but it is a collateral based loan, so the interest rate will always be lower than a credit card or a student loan. If you are pulling out cash to pay off credit cards or pay for a student loan, you will be paying a lower interest rate, which again, is tax deductible interest. Check 2nd-mortgage rates today.
#5 HELOC Provides You with Emergency Cash
Some people like to get a home equity line just so they have cash available in an emergency. If you are the sort of person who wants to have peace of mind by having money available in an emergency, a home equity credit line is a good thing to have handy.
#6 Your Credit Score Has Less Effect
Usually you need to have good credit to get a home loan, but your current credit score will not have as much of an effect on your ability to get a loan. The home is collateral for the loan. If you don’t pay, the lender will take the home after a few months. But for many people who need cash and have equity, not having to worry too much about credit scores is helpful.
Generally to get a home credit line, the bank will just require a current appraisal and verification of your income. If you have a fico score below 600, ask about bad credit home equity loans and lines.
#7 Loan Process Is Faster
When you got your first mortgage, you might remember a long process of two months or more to get your loan. That is because the loan had to go through a full underwriting and documentation process that can take 60-90 days and even more.
But with a home equity line, you are just going to need income verification and an appraisal. This means that you can get your money in a matter of a few weeks.
#8 Many Choices of Home Equity Lenders
After the financial crisis, lenders were offering a lot fewer HELOCs, but now there are more lenders offering them. We recommend that you visit a credit union and a mortgage broker at least to help you secure the best home equity line of credit rate. It will always pay for you to shop around.
The Reality on Home Equity Credit Lines
There are many great advantages of home equity lines of credit. Before making a financial commitment, we suggest doing your due diligence and comparing the HELOC and home equity loan, so you can make a sound decision. Used properly, you will have ready access to tax deductible cash that you can use for whatever you want. And, the interest rate on it will be lower than you would pay on most other loans.
Rules and Standards for Home Equity Lines of Credit
There are many ways to increase your overall wealth. But owning your own home is thought of as one of the most effective ways. Being a home owner rather than a renter allows you to build equity in a home that will most likely grow in value over the years.
Plus, paying down your mortgage over time means that you will eventually own the home outright.
Another benefit of owning your home is that if you need a large amount of cash, owning your house can be useful. For example, say you want to do a major rehab on your house. Or, perhaps there is a medical emergency in your family. If you have enough equity in your property, you can get a home equity credit line or a fixed 2nd mortgage loan.
By taking out a home equity line, you can tap into the growing value of your property. The other options are usually to take out a personal loan or to run up credit cards with high interest rates. As a home equity line of credit will use the property as collateral, they are much less risky for lenders. A home equity credit line will feature a much better interest rate than other types of loans.
Meet Bankers, Lenders and Brokers offering Competitive Home Equity Credit Lines for Homeowners with all types of credit backgrounds.
What Are the Home Equity Line of Credit Requirements?
If you want to take out equity in your home with a HELOC, here is what you need.
Home Equity
Obviously, you have to have equity in the property. This is defined as the difference between the fair market value of the house, and the balance of your mortgage.
To take out a home equity line of credit, lenders mostly want to see home equity exceeding 20% after the loan closes. So, if your home has a fair market value of $200,000, this means that the total amount owed in the property has to be under $160,000, including your mortgage and the home equity line of credit.
This may seem unreasonable to some parties. But lenders after the market crash of 2007 and 2008 have decided to err on the side of caution. They generally require borrowers to have a 20% stake in their home at all times. This reduces the risk to the home equity lender and its investors. A borrower with a 20% stake in the home is a heck of a lot less likely to stop paying the mortgage and walk.
Credit History
You need to have a reasonable credit score to take out another loan on your property. The good news is that because the loan is secured by the home you live in, the credit standards aren’t usually that difficult. Some home equity lines of credit are available to people with average to poor credit, albeit at higher interest rates. Those with poor credit also must have solid proof of income and have plenty of equity available.
If you have good credit, you will be able to breeze through the approval process and get approved with the best home equity credit line rate possible.
You Have to Have Steady Income
It should go without saying that people who borrow money in a mortgage loan have to show that they have the ability to repay it. This means that you have to show you have a steady work history and prove that you can make the monthly payments.
Home equity lenders want to see your job history going back several years, including your income and all other financial obligations on the application. If you do not have a regular job or a steady level of income, you could have difficulty qualifying for a home equity line of credit.
Low Debt to Income Ratio
In addition to having enough equity, lenders want to loan money to people who have a lower debt to income ratio or DTI. If you have several other loans and debts, you could have a harder time taking out an equity loan, no matter the level of equity in the property.
The requirements for DTI will vary, but generally, lenders like to see it in the range of 45% or lower. This will include the total payment for your mortgage, home equity line of credit, and all other debt payments. These include car loans, credit cards, child support, student loans and anything else.
If you have debt obligations beyond 45% DTI, most home equity lenders will conclude that you are stretched too thin to borrow more money.
Finding the Best Home Equity Lines
If you have enough equity in your home, a home equity line of credit can be a good fit for your financial needs. Interest rates on HELOCs vary with the market, so you need to be comfortable with some degree of variance in the payment schedule. If you are not, a home equity loan with a fixed interest rate may be preferable.
The best method to get a good rate on your HELOC is to shop different home equity line lenders. Be sure that you are looking at the closing costs and fees involved as well.
The Bottom Line on Home Equity Credit Lines
Borrowing equity from your property in the form of a home equity line of credit can be an effective, low interest way to get the money you need. Remember that the payment can vary if interest rates go up in the coming years, so you need to have enough income to pay for that potential increase in payment.
References:
- Retrieved from, Home Equity Loan Requirements. (2017, Jan. 20).
About RefiGuide.org
Bryan Dornan is a financial journalist and currently serves as Chief Editor of RefiGuide.org. Bryan has worked as a mortgage loan officer in the industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. Bryan's continual focus is to promote affordable home-ownership to consumers like you across the United States. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.
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