Do you need extra money for a vacation, car purchase, or another big-ticket item? It can take months or years to save up for these purchases, but a home equity line of credit can give you the money you need. Homeowners can use these credit lines to access a lot of money within a short amount of time. This guide will explore how home equity lines of credit work, the requirements, and how to apply for a HELOC.
What Is a Home Equity Line of Credit (HELOC)?
A home equity line of credit is a financial product for homeowners. This line of credit lets you tap into extra cash based on how much equity you have built up with mortgage payments and property appreciation. The more equity you have in your home, the more capital you can borrow through a home equity line of credit.
How Do Home Equity Lines of Credit (HELOCs) Work?
A home equity line of credit is tied to your home’s equity. Most lenders will not let you take out a home equity line of credit equal to your entire equity position. If the lenders limit you to accessing 80% of your home equity, and you have built up $500,000 in home equity, you can take out a HELOC of up to $400,000. That’s more than enough to cover many expenses. A recently laid-off worker who owns a home can use this line of credit to stay afloat while looking for a new job.
Where to Get Home Equity Lines of Credit (HELOCs)
Traditional mortgage lenders, financial institutions, and private lenders offer home equity lines of credit. You should reach out to multiple lenders and compare offers to make sure you get the best interest rates and terms.
HELOC Interest Rate Options
Homeowners can choose from two types of interest rates for their HELOCs.
Variable Interest Rate
Variable interest rates start out lower than their counterparts. However, these interest rates will increase if rates increase across the market. For instance, if the Federal Reserve hikes interest rates again, the interest rate on your HELOC will increase. You start with lower interest payments, but there is more uncertainty about what your interest payments will look like in a few years.
Fixed Interest Rate
Fixed interest rates typically start out higher than variable interest rates. However, they provide stability, and you won’t have to worry about your interest rate increasing in the future. Fixed interest rates may have higher initial payments, but they are less risky than variable interest rates.
Comparing HELOCs
Homeowners can tap into their home equity through HELOCs and other financial products. Here’s how credit lines compare with some of the other options.
HELOCs vs. Home Equity Loans
Home equity lines of credit only accrue interest if you borrow against the credit line. However, home equity loans charge interest the moment you receive capital. It’s possible to have a HELOC in reserves and never use the credit line, thus minimizing your interest payments in the process.
Home equity loans tend to have more predictable monthly payments, and you can get out of debt sooner with a loan. However, a HELOC has more generous payments in the beginning. At the end of the HELOC’s term, the remaining balance converts into a loan.
HELOCs vs. Cash-out Refinancing
A HELOC allows you to retain your current mortgage. If you like your current monthly payments and interest rates, a HELOC makes more sense than a cash-out refinance. However, if you don’t have the best terms for your mortgage, a cash-out refinance may be the better choice. A cash-out refinance can also help you reduce your monthly mortgage payments by extending the loan’s duration. Turning a 10-year mortgage into a 20-year mortgage will minimize the monthly payments, even if you get stuck with a higher interest rate.
HELOCs vs. Shared Home Equity Agreements
HELOCs give you extra cash but also make your debt-to-income ratio less favorable. It can be more difficult to get future loans while you are addressing your HELOC, mortgage, and other financial commitments. A home equity agreement allows you to give a company a percentage of your home equity in exchange for cash. You don’t have to worry about the home equity agreement and paying it back until you sell your home.
Home equity agreements allow companies to profit from your home’s rising value. However, if your home loses value, the equity you give up will become less valuable. Even in that scenario, you still get to keep the cash you received earlier. Home equity agreements are more favorable if your home doesn’t appreciate much or loses value. However, you can leave a lot of money on the table in the long run if your home’s value skyrockets. Homeowners should keep home equity agreements in mind when selling their properties so they don’t over-calculate how much they will have after the sale.
Advantages of Home Equity Lines of Credit (HELOCs)
Home equity lines of credit present several advantages for investors. These are some of the key perks.
Lower Fees and Costs
HELOCs are more affordable to open than some other home equity financial products. These lower fees and costs allow you to use more of the equity for its intended purpose.
Lower Interest Rates
Some HELOCs feature lower interest rates than other financial products, especially if you look beyond home equity products. Since a home equity line of credit uses your home as collateral, you can get lower interest rates compared to unsecured loans, like personal loans. A lower interest rate can help you save thousands of dollars while borrowing the same amount of money.
Low or No Closing Costs
Closing costs can make a serious dent in your finances and impact your ability to get a loan. HELOCs have lower closing costs than other financial products. Some financial institutions even offer home equity lines of credit that do not have any closing costs.
Charge Only What You Borrow
Interest only accrues on any capital you borrow against the credit limit. If you have a $500,000 home equity line of credit, and you borrow $100,000, you only pay interest on $100,000. Paying off the debt quickly will minimize interest accumulation, just like with credit cards. Installment loans do not give borrowers this luxury, and some of those same loans come with penalty fees if you pay off the loan early.
Who Are Eligible for a Home Equity Line of Credit (HELOC)?
Each lender has different eligibility requirements, but you must be a homeowner with enough equity built up to qualify. Some lenders will not let you exceed 80% of your home’s equity between the HELOC and your remaining mortgage balance. Other lenders are more generous with their limits. Financial institutions will also look at your finances to gauge if you can keep up with payments and manage another financial obligation.
What are the Requirements for a Home Equity Line of Credit (HELOC)?
If you want to get a home equity line of credit, you will need to focus on these key areas.
Home Equity
Mortgage lenders will check your home equity position before giving you a HELOC. Many banks and credit unions let you borrow money equal to up to 80% of the home’s equity. This limit is the loan-to-value ratio and also considers your mortgage.
Assume a homeowner has a $1 million home and paid off $300,000 of the mortgage balance. If the lender limits the homeowner to 80% equity, the homeowner can borrow up to $100,000 through a HELOC. That’s because the $700,000 mortgage balance and the $100,000 add up to 80% of the home’s equity.
Your home equity increases with each on-time payment and through property appreciation. If your home’s value has doubled over the years, you may be able to qualify for a higher home equity line of credit than you expect. It’s also possible to use a HELOC to make updates to your home. Those upgrades will improve your home’s value and can help you qualify for a higher HELOC in the future.
Credit Score
Financial institutions will often ask for your credit score when you apply for a loan. No credit check loans don’t require you to show your credit score, but they come with the worst interest rates and terms. However, every lender offering a HELOC will want to check your credit score before giving you the loan.
Many lenders post their minimum credit score requirements. Some lenders may accept a credit score as low as 620 for a home equity line of credit. These financial products typically have more generous credit score requirements than home equity loans.
Raising your credit score before getting a home equity line of credit can help you secure a lower interest rate and more capital. Making on-time payments and keeping your credit card debt low are two of the best ways to increase your credit score. Don’t settle for the minimum credit score requirement when you can raise your score by extra points with good financial discipline.
Debt-to-income Ratio
Your debt-to-income ratio measures your monthly debt obligations against your monthly income. If you make $8,000 in loan payments each month and earn $10,000 per month, you have an 80% debt-to-income ratio. That type of debt-to-income ratio will not help you qualify for a home equity line of credit.
Many lenders post their debt-to-income ratio requirements online. Having a debt-to-income ratio below 47% will improve your chances of getting approved. You can lower your debt-to-income ratio by paying off more debt, refinancing it to minimize your monthly payments, and making more income.
Income
Your income is a key component of the debt-to-income ratio. Lenders will also assess your income number to gauge the impact of a HELOC. Some borrowers have good debt-to-income ratios, but the debt they wish to incur can make their finances less savory for lenders.
Increasing your income through side hustles, career advancement opportunities, or a side job can help you get a better HELOC. Earning more income also gives you more choices. You can choose to get out of debt sooner, invest in assets, or build an emergency fund. There are many strategies to improve your finances, but none of them are as effective as raising your income.
Payment History
Creditors look at your payment history to assess how you manage your current financial obligations. Making on-time loan payments and making more than the minimum payment on your credit card will improve your payment history and credit score. Building good financial habits will go a long way to building your payment history, and it’s easy to see why lenders prioritize this information.
A home equity line of credit represents another commitment, and any struggles with managing loans and credit card debt can hurt your chances of receiving a HELOC. Lenders don’t want to take excessive risks, knowing that the borrower may not have enough money to pay off the line of credit. A better payment history can help you secure lower interest rates and better terms for your home equity line of credit.
How Long Does It Take to Get a HELOC?
The amount of time it takes to receive a HELOC depends on the lender. Online mortgage lenders typically provide HELOC funds sooner than traditional banks and credit unions. It can take 2-6 weeks for a homeowner to receive a home equity line of credit after submitting an application.
How to Apply for a Home Equity Line of Credit (HELOC)
Want to get a home equity line of credit to cover living expenses, help with an upcoming vacation, or anything else? It’s your equity, and you can follow these steps to apply for a HELOC.
Compare and Choose Your Lender
Homeowners should compare multiple lenders before committing to an offer. It is a good idea to read the online reviews for each lender to make sure they are legitimate. Then, you should look at the loan offers. You shouldn’t stick with your favorite bank or credit union if that financial institution has a significantly higher interest rate than the competition.
Choosing the first lender you find or working with the same lender without considering alternatives can become costly. You can save thousands of dollars and tap into more of your home equity by choosing the right lender.
Prepare Needed Documents and Forms
Homeowners have to gather several documents and forms to apply for HELOCs. You will have to provide personal documents and details, such as your ID, Social Security number, your home address, and your employer’s name and home address.
Homeowners must also provide documents that verify their income, such as two years of W-2 forms and recent paystubs. Lenders may also request your recent bank account statements and information about your investment and retirement accounts.
You will also have to gather documents that prove your ownership of the property and reveal how much capital you have left on the mortgage. Some lenders may require additional documents. It’s a good idea to check with your lender throughout the process. Missing a document and not getting back to the lender in a timely manner will delay the HELOC application process.
Get a Home Appraisal
A home appraisal helps the lender assess your home’s current value. Having an updated number will help the lender decide how much you can borrow for a home equity line of credit. The lender will get the home appraised and then let you know how much you can borrow. Knowing your home’s current value will also give you an idea of how much you can receive from selling your home.
Get Ready for Closing
Once the lender is ready to enter the closing process, you will receive paperwork that you have to sign. The property’s owners must be present during the closing. Some of these closings take place in person, while others take place online. You will need your personal ID and Social Security Card during this process. Lenders will want to verify your identity before the closing gets finalized.
You will have to pay any fees that have accrued at closing. These fees may include the origination fee, administrative fee, appraisal fee, title search fee, and other expenses. Some lenders charge more than others. Borrowers who take out loans can have the closing costs rolled into the back end of the loan.
Even after completing the closing, you will not have access to your funds just yet. Borrowers have a three-day grace period. This grace period, also known as “The Three Day Cancellation Rule,” lets you walk away from a home equity line of credit or loan after three days. It’s designed to give homeowners some time to think about their financial decision before it becomes official.
Access Your Funds
After the three-day cooling period expires, you can access your funds. You can use the funds in any way you desire. Homeowners only pay interest when they borrow against the credit line. You will see the funds in your bank account when the 3-day cooling process concludes.
