What is a Home Equity Line of Credit and How Does it Work?

If you have financial goals such as making renovations to your home or consolidating high-interest debt, you might want to consider using the equity in your home to fund your purchases.

You can borrow against your equity by securing a home equity line of credit (HELOC). With a HELOC, you gain access to a line of credit that you can use as needed, similar to a credit card.

How Does a Home Equity Line of Credit Work?

A home equity loan allows you to borrow against the equity in your home. It is secured by your property, which allows you to secure lower interest rates.

Instead of getting one lump sum, you gain access to a credit line that you can use as needed. You can borrow as much or as little as you need during your HELOC draw period, which is typically over 10 years.

You’re only responsible for making payments on the portion of your credit line that you borrow against.

How Do You Qualify for a Home Equity Line of Credit?

To qualify for a home equity line of credit, you first have to ensure that you have equity in your home.

You calculate your home’s equity by subtracting your mortgage balance from the value of your home.

For example, if your home has a value of $350,000 and a mortgage balance of $200,000, you have $150,000 in equity. You can then get a credit line for a portion of that amount.

Once you have the equity to qualify, your lender will review your credit history, employment history, debt to income ratio, and other factors. Overall, you’ll find the requirements to be similar to when you got your original mortgage.

What’s the Difference Between a Fixed vs. Variable Rate?

Your HELOC can offer a fixed or variable rate.

Fixed-rate

A fixed-rate HELOC allows you to have a consistent interest rate so your payments are more predictable. This is beneficial because you don’t have to worry about your interest rates increasing and locking in a low rate initially enables you to keep that same rate whether interest rates increase or decrease.

On the other hand, if interest rates decrease, you won’t be able to take advantage of the lower rates.

Variable-rate

Typically, your HELOC will have a variable rate. This means that your rate will fluctuate based on the market.

Variable-rate HELOCs have pros and cons. When interest rates are low, you will experience lower payments, but when rates increase, your payments will go up.

Due to the potential for unexpected changes in payments, you want to maintain flexibility in your budget in case you have to pay more for one month than you planned.

The good thing is that most variable-rate loans come with a minimum and maximum interest rate.

How is Money Disbursed with a HELOC?

When you get a home equity line of credit, you receive a line of credit that you can use as needed. You will have access to the balance of the line of credit during your draw period.

What Financial Institutions Offer HELOCs?

You can secure a HELOC from a bank or credit union.

What are the Costs Associated with a HELOC?

To finalize your home equity line of credit you will need to pay closing costs, like with a primary mortgage. HELOC closing costs tend to be lower than with a primary mortgage but generally range between 2%-5%.

The closing costs will pay for fees such as:

• Application/origination fee
• Notary fee
• Title search fee
• Appraisal fee
• Credit report fee
• Attorney/document prep fee
• Recording fee

Who are HELOC Loans Best For?

A home equity line of credit is best for you if you want access to funds to make purchases over time. This might be the right move if you are paying for home improvements or consolidating your debt to achieve lower interest rates.

As long as you don’t need a lump sum of cash, a HELOC is a great option to consider.

What’s the Application Process for a HELOC?

The process of applying for a HELOC is similar to getting a mortgage. Here is the general process to expect:

• Complete your application: You can complete your application online, and some lenders allow you to do so at a branch or on the phone. You want to have all of your documents available to make the application process easier.
• Initial decision: After reviewing your application and other information such as your credit history and debt to income ratio, an underwriter will provide you with an initial credit decision.
• Home appraisal: Now your lender will assess the value of your home and confirm your equity. This might require an appraiser to visit your home to complete an inspection, though this isn’t always the case.
• Final decision: After your appraisal, your lender will provide you with final approval and terms of your HELOC.
• Closing time: Finally, you will get a closing date for your HELOC. For your closing, you will go to the branch and complete all the necessary paperwork.

A HELOC is a great low-interest way to secure the funds you need to finance your purchases.

Click the button below to discover more about how you can take advantage of the equity in your home with a HELOC.