What Is a Home Equity Line of Credit or HELOC?
When you have equity in your home (the amount it’s worth minus how much you owe), you can leverage it to pay for high-cost expenses in life. These can range from tuition bills to home renovations, to the consolidation of high-interest debts.
One way to get cash from the equity in your home is with a home equity line of credit—also known as a HELOC. You might be wondering what a home equity line of credit is and how it works. We’ll explain it and help you decide if it’s the right option for you since they’re often misunderstood.
What Is a HELOC?
A home equity line of credit is a type of loan that is secured by the equity you’ve built in your home. Your home’s equity is essentially how much of your home you personally own. It’s calculated by taking your home’s value and subtracting your mortgage balance from it.
HELOCs offer competitively low-interest rates because your home acts as the collateral for the credit line, which is why they are referred to as secured loans. A HELOC differs from a home equity loan in that you do not need to know exactly how much you need to borrow at one time.
With a traditional home equity loan, the funds are disbursed in a lump sum, with equal payments being due over the life of the loan. With a HELOC, you have an open line of credit that you may draw from as needed, and you only pay interest on the funds you draw.
How HELOCs Work
HELOCs work similarly to traditional credit cards, except line amounts tend to be larger and your home is used as collateral. Your line amount is based on the available equity in your home, and you can choose when and how much to draw funds from the line. At Freedom Credit Union, we’ll approve you for up to 90% of your home’s equity.
HELOCs charge a variable interest rate, which means that the amount of interest you pay each month will vary.
At the start of a HELOC, there is a “draw period” during which time you can withdraw funds. At Freedom, your draw period lasts 5 years. You can borrow a lot or a little from the HELOC. Either way, you’ll only be required to pay interest on the money you actually take out during the draw period.
After the draw period, the repayment period begins. During this phase, you can no longer borrow money and you must start paying back the remainder of the loan plus interest. You’ll make monthly payments until the line of credit is paid off.
General Requirements to Qualify for a HELOC
To qualify for a HELOC you must meet certain financial requirements. In general, these are set by the lender who will look at the equity you have in your home, your debt-to-income ratio, and your credit score before making a decision about whether or not you qualify for a HELOC.
Your financial data can also affect the interest rate you’re offered. Therefore it’s wise to review your credit score and estimate the equity in your home in advance so that you can clear up any errors before applying and expedite the approval process.
You can use HELOC funds for a variety of purposes, but home improvements tend to be one of the most common. For example, you can use the money to remodel a bathroom, build a patio, or renovate your kitchen.
Considering that the value of your home increases when you make renovations, a HELOC may help you gain a positive return on investment in the long run if you sell your home. You can also use a HELOC to consolidate debt or finance large expenses like a wedding, family vacation, or college tuition.
Because there are no application fees, closing costs, or annual fees related to having a HELOC, you may consider setting one up for emergencies or unforeseen expenses.
Options Outside of HELOCs
Another option besides a HELOC is a home equity loan. A home equity loan is cash in a lump sum that you have to start paying back immediately. But unlike a HELOC, a home equity loan has a fixed-interest rate, which means your monthly payments will remain the same. This helps make budgeting easier because what you owe every month never changes.
Both home equity loans and HELOCs are secured loans, so your home serves as collateral. This means that if you default on either of these loans, the lender has the right to take your home. Personal loans are a third alternative but these are usually unsecured with higher interest rates.
Learn More About Our Home Loans
To help our members reach their financial goals, Freedom offers both HELOCs and home equity loans. Click below to learn more about the similarities and differences between these types of loans before making a decision about which one is right for you.