HELOC: Frequently asked questions about the credit limit for domestic equity

A home equity credit line (HELOC) is a type of loan that allows you to borrow and repay money as you need it for a specific period of time. It essentially works as a credit card secured by your home, as the funds are based on your available own funds. Because of its flexibility, a home equity credit line is a great choice if you have ongoing projects such as home renovations.

How does a HELOC work?

Unlike a home equity loan, which involves lending a fixed, lump sum, HELOC is a recyclable form of credit. Works like a credit card.

When you apply for a HELOC, you will be given a credit line based on your available home equity – you can usually borrow up to 85 percent of your home equity, less mortgages. During the specified draw period, you can withdraw money from the account using exclusive checks or a draw card. You will need to make a minimum monthly payment for the amount you are borrowing, but as you repay your HELOC, the funds will be replenished. This lottery period usually lasts 10 years.

After that, you will enter a repayment period, during which you will no longer be able to access funds and repay the capital. Most HELOC programs allow you to repay the balance over a period of 10 to 20 years.

How to qualify for a HELOC

Each lender will have their own requirements for obtaining a HELOC, but there are some general criteria that lenders will consider when deciding whether to approve your application.

  • Share capital in your home. Most lenders require homeowners to have at least 15 percent to 20 percent equity in their homes.
  • Good credit. Homeowners with credit scores in the mid-600s and older have the best chance of being approved for HELOC.
  • Debt to income ratio. Many lenders will look for a reasonable debt-to-income ratio, generally approving applicants at a rate of 43 percent or lower. Be sure to calculate the debt-to-income ratio before applying.
  • Adequate income. Before you apply for a HELOC, a lender will evaluate your annual income to ensure that you can afford your monthly payments.
  • Responsible payment history. If lenders see a history of late payments, they are unlikely to approve your application because you may not be able to make your new loan payments on time.

Types of interest rates in HELOC

You will almost always encounter variable interest rates with HELOCs, but some lenders offer exceptions.

Variable interest rates

Like credit cards, HELOCs have a variable interest rate, which means that your monthly payment will vary depending on your current interest rate and the amount you borrow at any given time.

The variable interest rate on your loan is determined in part by indicators communicated to the public, such as the base US interest rate. The key interest rate is set by the collective financial institutions and is influenced by the fluctuations in the interest rate of the federal funds (the interest rate that banks charge from other banks for short-term loans).

Because the key interest rate is affected by market conditions and economic conditions, it causes the HELOC interest rate to increase or decrease over time. As interest rates change and you withdraw from your HELOC account, the monthly payment you owe will also change. However, there is a legal limit to how much your rate can increase over the life of the program.

Fixed interest rates

Some lenders offer the opportunity to lock in a portion of their HELOC balance at a fixed rate, effectively converting part of your HELOC into a mortgage. Companies that offer fixed rate HELOC options usually allow you to repay this portion of the loan over a period of five to 30 years, although the balance must be repaid by the end of the regular HELOC repayment period. Companies can also allow you to have multiple price locks at any time.

The option to lock in a portion of your HELOC could be helpful if interest rates are low and you do not want to risk raising them during your repayment period. If you’re interested in this option, look for companies that advertise “HELOC hybrids” or fixed price locks.

The bottom line

HELOCs are worth considering if you want the freedom to borrow as little or as much as you want, and do it on your schedule. But keep in mind that HELOCs require discipline and a variable interest rate makes them slightly more volatile than home equity loans. However, if you are looking for access to funds for current projects or expenses, try getting offers from some lenders to see what they can offer you.

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