What is the Housing Equity Credit Line (HELOC)?
A home equity line of credit or HELOC is a type of renewable credit line backed by the borrower’s own funds in his home. If you are unfamiliar with the concept of home equity, it is the difference between the market value of your home and any existing mortgage you owe it. For example, if you have a $ 250,000 home and you have a $ 150,000 home loan balance, you have $ 100,000 in home equity.
When a borrower applies and receives a HELOC, he does not receive money immediately. Instead, they take a credit line with a limit set by their lender from which they can choose to draw as they need funds.
How does a HELOC work?
When applying for a HELOC, the lender will usually evaluate your home to determine its current market value. From there, the lender will calculate the maximum amount of mortgage debt that can justify the value of your home and then subtract any existing mortgage debt to determine how much you could borrow on a HELOC.
HELOCs usually have a draw period where the borrower is allowed to access their HELOCs to borrow money. Some HELOCs only charge the borrower’s interest (not capital) on their monthly payment during the draw period. Then, at a predetermined time, HELOC moves from the draw period to the repayment period. During the repayment period, the borrower is required to make principal and interest payments and is no longer able to access any unused HELOC borrowing capacity.
During the lottery period, which usually lasts up to 10 years, there are usually several ways in which the borrower can access his HELOC. They may have a debit card linked to the credit line or they may have a checkbook. In some cases, a HELOC borrower may be able to use his / her lender’s portal to transfer money to his / her bank account from HELOC.
With regard to interest rates, there is no specific empirical rule. HELOCs are not standard products in the sense of conventional mortgages, so you may see HELOC interest rates differ significantly from lenders.
Most HELOCs have variable interest rates linked to a specific reference rate, such as the base rate. Many come with a low “teaser” rate for the first year or so. But in most cases, the variable interest rate you pay on a HELOC will be significantly higher than the current 30-year mortgage rate.
The main reason you are likely to see a higher HELOC interest rate is that, although HELOC is secured by your home, the lender is usually second to your main mortgage lender. In other words, if you stop making payments, your main mortgage lender can block and get the money owed first before the bank that issued your HELOC sees a penny.
To be clear, there are fixed rate HELOC loans. Some select lenders offer a fixed rate loan option. But the vast majority of HELOCs have variable rates.
What are the requirements for a HELOC?
The main requirement for a HELOC is to have sufficient equity in your home from which you can borrow. The most common ceiling in the mortgage industry is the loan-to-value ratio (LTV) of 80%, so if your home mortgage is equal to 50% of the value of your home, you could possibly get a HELOC with a limit equal to at 30% of its value.
Some lenders have slightly higher LTV ceilings of 85% or even 90%. In any case, your home should be worth much more than you owe your home mortgage for a HELOC to be possible.
You will also need to qualify for a HELOC based on your credit score and income. Although HELOC is secured by equity in your home, the lender will want to verify that you are able to repay it and possibly make your payments on time.
HELOC vs. Mortgage: What’s the Difference?
Domestic equity lines of credit and home equity loans are terms that are often used interchangeably, but actually refer to two very different loan products. Both are forms of “second mortgage”, meaning they are loans backed by the value of your home and can be created in addition to an existing mortgage.
The biggest difference between the two is that with a home loan, you borrow a fixed amount and make regular and consistent loan payments. For example, you may receive a $ 40,000 home equity loan and you will receive (and owe) the full amount whether you intend to spend it or not.
A HELOC, on the other hand, is a line of credit that you can access as needed (or not at all). From a technical point of view, a home equity loan is a form of installment loan debt, like a home equity loan, while a HELOC works as a type of revolving debt, similar to a credit card.
learn more: HELOC against home equity loan
How to find the best HELOC lender
Just like when shopping for a home mortgage, it is important to shop. Interest rates, closing costs and other commissions vary dramatically between HELOC lenders.
A good place to start is our list of the best HELOC lenders you will find on this page. Choose the ones that meet your needs and then apply with some of them to see the HELOC terms that will be offered to you. You may be surprised at how different your HELOC offers are from lenders. Once you do that, just pick the best one and accept the offer.