What Is a Home Equity Line of Credit (HELOC)?
Updated: Nov 23, 2022
A home equity line of credit (HELOC) is a secured loan in which lenders agree to lend to borrowers a certain amount up to a certain limit within a set period. The maximum amount borrowers can borrow depends on the lender's lending terms and conditions. Typical conditions include a maximum debt-to-income ratio and a minimum credit score to qualify.
Home Equity Line of Credit
A Home Equity Line of Credit (HELOC) allows borrowers to borrow money against the equity in their home. Most lenders allow borrowers to borrow up to 85% of the value of their home. This type of line of credit allows them to draw funds as needed as long as there is equity available in the house. The interest rate borrowers pay includes a variable portion and can change from month to month, based on the changing 5-Year Benchmark Rate set by the bank.
Unlike a traditional bank loan, a home equity line of credit is flexible. It allows borrowers to draw money as needed and repay in full without any prepayment penalty. The funds are secured by the available equity in the home, meaning the lender can follow through with the foreclosure procedure if the borrowers default on the loan.
When choosing a lender, be sure to read the disclosures carefully. Work with a mortgage broker to make sure the lending terms are fair and suitable for the situation.
A HELOC can be a great way to pay off student debt or other expenses. It's flexible, but borrowers must make sure you know what the terms are before signing up for a home equity loan. There are two main types of home equity loans: installment loans and revolving lines. The former is fixed, while the latter has variable interest rates.
When compared to personal loans that don't require collateral, and the interest rate for HELOC is much lower. A HELOC is often better for consolidating credit card debt or other personal debts into one secured loan. However, it's important to note that consolidating debt is only beneficial when the new mortgage payments are lower than the original loans combined.
When performing cash-out refinances combined with HELOC, borrowers can enjoy a number of benefits from the HELOC because this solution allows repayment at any time without prepayment penalty. They can be particularly beneficial if homeowners need to make a large purchase or pay for a down payment to a second home.
The fixed portion of the mortgage refinance can make the mortgage payments predictable, while the HELOC with a revolving line of credit lets borrowers to tap to the available equity in the property on demand. Borrowers only had to pay for the amount withdrawn against the line of credit. Therefore, HELOC works like a credit card, but it is secured by the real estate property as a collateral.
To take advantage of cash-out refinancing, lenders must first assess the borrower's financial situation, and the current market value of the property. Borrowers will have to pay for an appraisal of the home.
Maximum Borrowing Amount
The maximum amount to borrow depends on the borrower's credit score and the combined loan-to-value ratio, which is equal to the desired home equity loan amount plus the existing mortgage balance. Borrowers who have a low debt-to-income ratio are more likely to be approved by lenders for the maximum amount. Lenders also favour borrowers who have an excellent beacon score and credit history, as many lenders want to ensure that the borrowers do not have high risk of going default.
The maximum amount that borrowers can withdraw from a HELOC also depends on the value of the property and how much of the loan balance owing. Most lenders require about 15 to 20 percent equity in the total value of the home to make that borrowers have "skin in the game".
Not all HELOCs are created equal
Before signing any HELOC contract with a lender, borrowers should review the loan agreement with a mortgage broker for a second opinion. Make sure that every lending condition is clear and the terms of the repayment period and the minimum withdrawal amount is defined on the contract.
Another benefit of checking with a mortgage broker is because at most times there are special discounts offered through the broker channel that homeowners would not have qualified by visiting a bank branch on their own.
Ask for an extended repayment period for borrowers who are focused on lowering the ongoing mortgage payment the lowest. Typically, repayment periods are 20 years, but they can vary.
Another consideration when making withdrawals from your HELOC is the fees that borrowers will incur on the closing day. These fees are commonly called as Closing Cost. These costs are not included in the primary mortgage, but they should be a factor in the overall decision. If borrowers can't afford to pay the closing cost, this could pose problem as the deal halted until the closing costs are fully paid. Work with a mortgage broker to get clear answers on the total Closing Cost before the closing day. Some lenders waive closing costs or allow borrowers to pay only a portion of these costs.
On average, closing costs for a HELOC are two to three percent of the total loan amount. Borrowers may also work with a mortgage broker to help negotiate closing costs with the lender.
Annual fee and introductory interest rate
There is no annual fee for opening and maintaining HELOC account. In most cases, the banking fee is related to maintaining the associated Checking Account, which is a separate banking account altogether.
Most banks offer introductory rates on HELOCs that are lower than normal APRs. However, borrowers should check the actual interest rate after the introductory period has expired. Borrowers want to make sure the HELOC is affordable even after the introductory rate has ended.