Do you have a large amount of equity in your home? You may be considering a home equity line of credit to access this amount when you need it. But before you apply, it’s vital to understand how these debt products work, what you’ll need to get approved for, and if there are better alternatives to convert your equity into cash.
How Do You Get a Line of Credit Using Your Home Equity?
Home Equity Lines of Credit (HELOCs)
A HELOC is a revolving credit line secured by your home that’s based on the equity you’ve built up. You can typically find these products through your local bank, credit union or other financial institution in your area.
Most lenders let you borrow up to 85 percent of the equity in your home, which is the value of your home minus the outstanding balance on your mortgage and amounts owed on any other loans against the house.
To illustrate, if you currently owe $247,000 on your mortgage, but your home is worth $459,000, you could get approved for a HELOC of up to $120,200 ($459,000 * .85 – $247,000).
How Home Equity Lines of Credit (HELOCs) Work
It gives you access to a credit line that you can borrow from and repay at any time during what’s known as the draw period. You’ll also make interest-only payments during the draw period, which typically spans 10 years.
When the draw period ends, you’ll generally have 20 years to repay what you owe in monthly installments. However, the payment amount could fluctuate since most HELOCs come with a variable interest rate.
What You Can Use The Funds of a Home Equity Line of Credit (HELOC) For
You’re free to use the funds you withdraw from a HELOC however you see fit. Some homeowners consolidate high-interest debt, make home improvements or big-ticket purchases, boost emergency savings, invest, start a business or contribute to their nest egg.
The benefit is there are no limitations on how the money can be spent, and you have the option to only take what you need.
How to Qualify for a Home Equity Line of Credit (HELOC)
You should have a substantial amount of equity in your home before applying for a HELOC. The lender will also evaluate your creditworthiness, monthly income, outstanding debt obligations and employment history.
Alternatives to Home Equity Line of Credit (HELOC)
Home Equity Sharing Agreement
Home Equity Sharing Agreements offer a debt-free alternative to tap into home equity. It allows you to convert a percentage of your home’s value into cash. Instead of taking on a loan, you’ll swap your equity for cash today. Here’s how it works:
- You agree to the conditions of the shared equity agreement.
- You receive a portion of your home’s equity in cash today to use however you want.
- You enjoy your co-investment without making monthly payments or accruing interest.
- You maintain full ownership of your home throughout.
- You sell your home or buy out the agreement at the end of the term
Co-investments range from $30,000 to $500,000, and you’ll need a credit score of at least 620 and an LTV that doesn’t exceed 75 percent to qualify.
Home Equity Loans
Like a HELOC, a home equity loan is a second mortgage that allows you to borrow up to 85 percent of your home’s equity. But instead of receiving a revolving line of credit, you’ll get the loan proceeds in a lump sum at closing and repay what you owe over a 20- to 30-year repayment period.
Home equity loans come with fixed interest rates so that the monthly payment will remain the same, and you’ll have to pay interest on the entire loan amount, even if you don’t use all the funds. And if you fall behind on the payments, you could lose your home to foreclosure.
Cash-Out Refinance
When you opt for a cash-out refinance, you swap your existing mortgage with a different loan with new terms, usually with a fixed rate. You’ll get a portion of your equity in cash at closing, typically capped at 80 percent, and your new lender will pay off the remaining balance on the old mortgage. The new lender will also roll the cash you pulled out into the new loan balance.
For example, assume you owe $175,000 on your home, and it’s now worth $310,000. If the lender approves you for a cash-out refinance, you could get up to $88,500 ($310,000 * .80 – $175,000) in cash at closing, and your new loan amount would be $263,500 ($175,000 + $88,500).
Before you take out a cash-out refinance, be mindful that you’re not guaranteed to get a lower rate. Furthermore, your monthly mortgage payments could be much higher and stretch your budget thin.
Calculate How Much You Could Borrow Using Your Home Equity
A HELOC could be a viable option if you want to borrow against your home equity. But you don’t have to settle for a loan and make monthly payments over a set period of time or use a personal loan, credit card or personal line of credit with higher interest rates to get the cash you need.
