Best HELOC Lenders of April 2022
Best HELOC Lenders of April 2022

What is a home equity line of credit (HELOC)?

A home equity line of credit, or HELOC, is a type of revolving line of credit that is secured by the borrower’s equity in their home. If you’re unfamiliar with the concept of home equity, it’s the difference between the market value of your home and any existing mortgage debt you owe on it. For example, if you own a home worth $250,000 and have a mortgage balance of $150,000, you have $100,000 of equity.

When a borrower applies for and receives a HELOC, they do not receive money immediately. Instead, they receive a line of credit with a limit determined by their lender that they can choose to draw on as funds are needed.

How does a HELOC work?

When you apply for a HELOC, the lender will typically appraise your home to determine its current market value. From there, the lender will calculate the maximum amount of mortgage debt the value of your home can justify, then subtract any existing mortgage debt to determine how much you could borrow on a HELOC.

HELOCs usually have a drawdown period during which the borrower is allowed to access their HELOC to borrow money. Some HELOCs only charge the borrower the interest (not the principal) in their monthly payment during the drawdown period. Then, at a predetermined time, the HELOC switches from the draw period to the redemption period. During the repayment period, the borrower is obligated to make principal and interest payments and is no longer able to access any unused HELOC borrowing capacity.

During the drawdown period, which typically lasts up to 10 years, the borrower can typically access their HELOC in several ways. They may have a debit card linked to the line of credit or a checkbook. In some cases, a HELOC borrower may be able to use their lender’s online portal to transfer money to their checking account from the HELOC.

When it comes to interest rates, there is no rule of thumb. HELOCs are not standardized products in the sense that conventional mortgages are, so you are likely to see HELOC rates vary widely from lender to lender.

Most HELOCs have variable interest rates that are tied to some benchmark interest rate, such as the prime rate. Many come with a low “teaser” rate for the first year or so. But in most cases, the variable rate you’ll pay on a HELOC will be significantly higher than the current 30-year mortgage interest rate.

The main reason you are likely to see a higher HELOC rate is that although the HELOC is secured by your home, the lender is generally in a second lien position to your primary mortgage lender. In other words, if you stop making payments, your primary mortgage lender can foreclose and collect the money owed to them before the bank that issued your HELOC sees a penny.

To be clear, fixed rate HELOC loans do exist. A few select lenders offer a fixed rate loan option. But the overwhelming majority of HELOCs have variable rates.

What are the requirements for a HELOC?

The main requirement for a HELOC is that you have enough equity in your home to borrow. The most common cap in the mortgage industry is an 80% loan-to-value (LTV) ratio, so if your primary mortgage is 50% of your home’s value, you could potentially get a HELOC with an equal cap. 30% of its value.

Some lenders have slightly higher LTV maximums of 85% or even 90%. Either way, your home will need to be worth significantly more than you owe on your main mortgage for a HELOC to be possible.

You will also need to qualify for a HELOC based on your credit score and income. Even though the HELOC is secured by the equity in your home, the lender will want to verify that you are able to repay it and likely to make your payments on time.

HELOC vs Home Equity Loan: What’s the Difference?

Home equity lines of credit and home equity loans are terms that are often used interchangeably, but they actually refer to two very different loan products. Both are forms of ‘second mortgages’, meaning they are loans secured by the value of your home and can be taken out on top of an existing mortgage.

The biggest difference between the two is that with a home equity loan, you borrow a predetermined amount and make regular, fixed payments. For example, you could get a $40,000 home equity loan and you will receive (and owe) the full amount whether you intend to spend it or not.

On the other hand, a HELOC is a line of credit available when needed (or not at all). Technically speaking, a home equity loan is a form of installment loan, like a primary mortgage, while a HELOC functions as a type of revolving debt, similar to a credit card.

Learn more: HELOC vs home equity loan

How to find the best HELOC lender

Just like when shopping for a primary mortgage, it’s important to shop around. Interest rates, closing costs, and other fees vary widely between HELOC lenders.

A good place to start is our list of top HELOC lenders on this page. Choose a few that meet your needs, then apply to a few of them to see what HELOC requirements you will be offered. You might be surprised how much your HELOC offers can differ from lender to lender. Once you’ve done that, just choose the best and accept the offer.

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