HELOC: Home Equity Line of Credit FAQ
HELOC: Home Equity Line of Credit FAQ

A home equity line of credit (HELOC) is a type of loan that lets you borrow and repay money as needed over a period of time. It basically works like a credit card secured by your house, since the funds are based on your available capital. Because of its flexibility, a home equity line of credit is a great option if you have ongoing projects like home renovations.

How does a HELOC work?

Unlike a home equity loan, which involves borrowing a fixed lump sum, a HELOC is a form of revolving credit. It works much like a credit card.

When you’re approved for a HELOC, you’ll be given a credit limit based on your home’s equity — typically, you can borrow up to 85% of your home’s value, less any outstanding mortgage balances. During the established draw period, you can withdraw funds from the account using dedicated checks or a draw card. You’ll have to make minimum monthly payments on the amount you borrow, but when you pay off your HELOC, the funds are replenished. This drawing period generally lasts 10 years.

After that, you will enter a repayment period, during which you will no longer be able to access the funds and will instead repay the principal. Most HELOC plans allow you to pay off the remaining balance over a period of 10 to 20 years.

How to qualify for a HELOC

Each lender will have their own requirements for getting a HELOC, but there are some general criteria lenders will consider when deciding whether or not to approve your application.

  • Equity in your home. Most lenders require homeowners to have at least 15-20% equity in their home.
  • Good credit. Homeowners with credit scores in the mid-600s and above have the best chance of being approved for a HELOC.
  • Debt to income ratio. Many lenders look for a reasonable debt-to-equity ratio, generally approving applicants with a ratio of 43% or less. Be sure to calculate your debt ratio before applying.
  • Sufficient income. Before you can be approved for a HELOC, a lender will assess your annual income to make sure you can afford your monthly payments.
  • Responsible payment history. If lenders see a history of late payments, they are unlikely to approve your application because you may not make your new loan payments on time.

Types of HELOC Interest Rates

You will almost always encounter variable interest rates with HELOCs, but a few lenders offer exceptions.

Variable interest rates

Like credit cards, HELOCs come with a variable interest rate, meaning your monthly payment will vary based on the current interest rate and how much you’re borrowing at any given time.

The variable interest rate on your loan is partly determined by public indices, such as the US prime rate. The prime rate is set by collective financial institutions and is influenced by fluctuations in the federal funds rate (the rate banks charge other banks for short-term loans).

Because the prime rate is affected by market and economic conditions, it causes your HELOC interest rate to increase or decrease over time. As interest rates change and you draw down your HELOC account, the monthly payment due will also change. However, there is a legal cap on how much your rate will increase during the life of the plan.

Fixed interest rates

Some lenders offer the option of locking in part of your HELOC balance at a fixed rate, essentially converting part of your HELOC into a home equity loan. Companies that offer fixed-rate HELOC options typically allow you to repay this portion of the loan over a period of five to 30 years, although the balance must be paid off before the end of your normal HELOC repayment period. Companies may also allow you to have multiple rate locks in place at any one time.

Choosing to lock in part of your HELOC can be useful if interest rates are low and you don’t want to risk them rising during your repayment period. If this option appeals to you, look for companies that advertise “Hybrid HELOCs” or fixed rate locks.

The bottom line

HELOCs are worth considering if you want the freedom to borrow as little or as much as you want, and to do so on your schedule. But keep in mind that HELOCs require discipline, and a variable interest rate makes them slightly more volatile than home equity loans. Still, if you’re looking to access funds for ongoing projects or expenses, try getting quotes from a few lenders to see what they can offer you.

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