Home Equity Line of Credit

HELOC

A home equity line of credit, or HELOC, is a popular way to access equity in your home. Unlike a standard loan that would pay out everything at closing, a HELOC means your lender promises to advance you a certain amount of money at times and amounts of your choosing. You can access your funds with checks or a special type of credit card.

Every HELOC has a draw period, or a time during which you can access your credit line, and a repayment period during which you must repay the loan. In most cases, the draw period will be five to 10 years. During this time, you will only pay interest on what you use. Your repayment period can last for 10 to 20 years, and during this time, your payments will go toward principal. Some HELOCs require the entire balance to be paid in full when your draw period ends, however.

Most home equity lines of credit are second mortgages, like home equity loans, although your HELOC can become your first mortgage if you use it to refinance.

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Benefits of a HELOC

A HELOC is often a better choice over a home equity loan if you have ongoing cash needs, such as irregular income.

Advantages of a HELOC include:

Only charged interest on money you withdraw
Pay down the loan and reborrow, if you wish
Draw funds as needed
Interest paid is tax deductible
Interest rates are usually low

Many homeowners turn to a HELOC to consolidate debt, including credit card and medical debt. HELOCs usually have interest rates that are higher than a primary mortgage, but still much lower than credit card or personal loan interest rates. Using a HELOC for debt consolidation can help you save a great deal on interest charges, but remember that your home is collateral on the loan, and if you default, you can end up in foreclosure.

Downsides of a HELOC

HELOCs are not right for every situation. The monthly payments can be unpredictable, as the interest rate variable is tied to the Prime rate, with no cap like you would get with an adjustable-rate mortgage (ARM). Changes in the market can affect the affordability of the loan.

If you need a consistent and predictable monthly payment, and you are on a fixed income, a home equity loan is likely the better choice.

HELOC Requirements

A HELOC allows you to borrow against the equity in your home. You must typically meet the following qualifications to get approved for a home equity line of credit.

You must have equity. Some lenders let you get a HELOC for up to 125 percent of your equity, but most do not allow you to borrow against more than 80 percent of your equity. A home appraisal will be necessary.
Monthly housing costs, including your mortgage payment and HELOC payment, cannot exceed 28 percent of your gross monthly income.
All monthly debts must not exceed 36 percent of your monthly income.
You must have good credit. The higher your credit score, the more you can borrow of your equity.
Steady employment with the same employer or in the same field.