Home Equity Line of Credit (HELOC): What It Is, How It Works
A Home Equity Line of Credit, known as a HELOC, allows you to apply for a line of credit using your home as collateral. This can be useful for a variety of large expenses, from home improvement projects like kitchen remodels, to college planning or even weddings.
While you might be able to secure a personal loan, a home equity loan or put these expenses on a credit card, you have other options. Learning more about how a home equity line of credit works and what you can use it for can help you make the right financial decisions to tackle a large project or cope with an unexpected expense.
What Is a Home Equity Line of Credit?
Different than a home equity loan, which is a lump-sum payment with a fixed-interest rate, a Home Equity Line of Credit (HELOC) functions more like a credit card and is considered a type of second mortgage. Instead of borrowing a lump sum all at once, you receive a total line of credit that you can then borrow against as you need to. A home equity line of credit differs from an unsecured credit card in one important way; the HELOC is secured with the equity in your home. Your equity is the amount your house is worth minus what you currently owe your lender.
How is a HELOC different than a home equity loan? A home equity loan gives you one lump sum all at once. This is helpful for a specific project where you know ahead of time the exact amount you need to borrow. However, a HELOC is more suited for longer-term borrowing, where the amount you need may fluctuate over time. Additionally, you only pay interest on the amount you’ve withdrawn from your HELOC, as opposed to paying interest on the full amount of a home equity loan.
Your HELOC will be for a set time frame/draw period (often 10 years) and you can draw on it when you need to. If your home needs a new air conditioner, you want to update your bathrooms or you have another improvement in mind, you can begin without delay, simply by using funds from the HELOC.
Additional potential uses for your line of credit:
If you decide a HELOC is right for you, you can apply online now or make an appointment at a branch near you. A loan specialist will work with you to determine if this product is a good match for you. Some factors to take into consideration include the value of your home, the amount of money you owe on your mortgage and your debt-to-income ratio and credit score (FICO score). The credit limit you get will depend on the amount of equity in your home. Most banks won’t loan above 80% of your LTV (loan to value ratio) – meaning the total amount of your outstanding mortgage plus the HELOC cannot be more than 80% of the appraised value of your home.
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For example, if the appraised value of your home is $350,000 then the total outstanding home loan balance (mortgage plus HELOC) for an 80% LTV would be $280,000. If you have $200,000 remaining on your mortgage, the amount you can obtain for a HELOC would be $80,000.
Appraised Home Value: $350,000
80% LTV ($350,000 x 80%): $280,000
Remaining Mortgage: $200,000
HELOC Amount: ($280,000 - $200,000) $80,000
This is just one idea of how a HELOC can work for you. When you are ready to apply, the process is faster than a mortgage and upon approval you’ll be able to access the credit line your lender has extended. The terms and conditions vary; you may have a minimum or maximum withdrawal to adhere to when you make a purchase. You’ll use the funds in this line of credit when you are ready to launch a project.
Variable Interest Rate VS Fixed Interest Rate (Carve Out) Option
If interest rates are a concern, consider all of your options before applying. HELOC interest rates are often lower than those of traditional home equity loans, but the interest rates are variable, meaning they can change over time as the market changes. When you withdraw money from your HELOC, you’ll receive monthly bills that include a minimum payment based on the principal and interest. Payments may change based on your balance and fluctuations of the interest rate.
Some lenders, like Seacoast offer a fixed-rate HELOC option also called a HELOC Carve Out loan which allows you to lock in a fixed rate instead of the variable rate, providing you fixed monthly payments for your line of credit. This can be useful in reducing concerns about potential rising interest rates. Minimum amounts are required and initial rate may change based on market conditions. Learn more about Seacoast Bank’s HELOC Credit Carve Out.
How Is a HELOC Repaid?
The funds you borrow are paid back over a specific period of time (borrowing period) that is established with the terms of your line of credit. Dependent upon the terms of your HELOC, during the borrowing period, you may only be required to pay the interest of the amount borrowed, making the payments affordable and accessible. At the end of the borrowing period, your total repayment plan can range from 10 years or more, during which you’ll pay both principal and interest. There is no penalty for paying off this line of credit early, so many borrowers choose to pay the HELOC off as funds are used.
Advantages of a Home Equity Line of Credit
One of the primary advantages of a home equity line of credit is the built-in flexibility; once your credit limit is approved, you can use your HELOC as little or as often as you need to. A few other advantages include:
Interest only payments during the initial borrowing period, making this an attractive option for those wary of high monthly payments.
Long repayment periods ensure that you have all the time you need to pay back your loan.
Convenience; you can take what you need, when you need it without waiting for approval or applying for a new loan.
Flexibility to use the funds on a variety of projects, wants, and needs.
Peace of mind that you have a line of credit readily available for unexpected emergencies and expenses.
Like any financial instrument, a HELOC can present some risk to borrowers; it is important to have a complete understanding of the pros and cons before determining if a home equity line of credit is right for you. A few things to consider include:
A HELOC may be more difficult to qualify for than a credit card; you have to have enough equity in your home to borrow against.
If you plan on selling your home soon, a HELOC is not your best option. You’ll need to pay off the home equity line of credit when you close on the sale.
A HELOC can have some additional costs, including closing costs. Check with your financial institution to learn about additional costs. Some institutions, like Seacoast Bank, have Home Equity Line of Credit options that do not include closing costs or may pay part of your closing costs.
Is a HELOC Right for You?
A home equity line of credit can provide you with a convenient source of funds, but does have some potential drawbacks to consider. A HELOC also provides the flexibility to make either interest-only payments or repayments throughout the term of your loan.