If you're a homeowner, you surely know that you can tap into your home’s equity. You can do this with a Home Equity Line of Credit (HELOC). But what exactly is this, and how does it work? More importantly, is a HELOC the right funding choice for you?
Here, learn everything you need to know before you apply for a HELOC.
What is Home Equity
Home equity is the value of the portion of your homethat you truly own outright. It is calculated as the difference between thecurrent market value of your home and the outstanding balance of any mortgageor loans secured against it. It’s a valuable asset that can be leveraged asneeded.
And, as you pay down your mortgage or as property values increase, home equity typically grows. This potentially increases your overall net worth.
Here's how to calculate it:
- Determine the estimated current value of your home. This can be based on factors like the real estate market, location, size, condition, and recent sales of similar properties in your area.
- Work out how much you still owe on your mortgage or any other loans secured by your home.
- Subtract the outstanding mortgage balance from the market value of your home.
The resulting figure represents your home equity. So,if your home is valued at $300,000 and you owe $200,000 on your mortgage, yourequity is $100,000. Home equity funding allows you to take a loan on apercentage (typically 80%- 90%) of the value of your home minus the amount owedon the first mortgage.
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What is Home Equity Funding?
Home equity funding is financing from a bank or lender backed by your home's equity.
It can give you the ability to pay for major expenses like:
- Renovate your home.
- Pay for education.
- Fund a vacation.
- Buy a vehicle.
If you need funds to pay for a major expense, home equity funding can be a simple way to obtain it.Loans secured by residential real estate are protected from discrimination under the Fair Housing Act.[1] So, you only need the means to repay and to meet the necessary credit qualifications of your lender.
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What is a Home Equity Line of Credit?
A HELOC is a loan that allows you to borrow against the equity you've built up in your home. With a HELOC, you can access your home equity as arevolvingline of credit.
Revolving credit is a type of arrangement in which you have access to a pre-approved credit limit that you can tap into as needed. As you use the credit, the available balance decreases. But once you repay what you've borrowed, that amount becomes available to use again without the need for reapplying. A credit card is another example of revolving credit.
Unlike installment loans with fixed payments, revolving credit offers flexibility in repayment amounts based on your outstanding balance. And, on a revolving account, you only pay interest on the amount you use.
When there's additional financing (like a HELOC) alongside a first mortgage, the lender needs to calculate the Home Equity Combined Loan-to-Value (HCLTV) ratio.[2]
Common alternatives to a HELOC are:
- Home equity loans (non-revolving)
- Cash-out refinancing (a new mortgage)[3]
Be sure to explore all options to determine the best for your situation.
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How Does a Home Equity Line of Credit Work?
Again, a HELOC uses your home as collateral. The amount of credit you can access is based on the difference between the current market value of your home and the amount you owe on your mortgage. Typically, lenders allow you to borrow up to a certain percentage of your home's equity.
If the funds are used for home improvements, the interest paid on a HELOC may be tax-deductible. However, tax laws can change. So, you shouldconsult with a tax advisor for specific advice.
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1. The Draw Period
Similar to a credit card, a HELOC provides you with a credit limit. You can borrow from this line of credit as needed during a specified “draw period.” Draw periods usually last around 10 years. During this period, you can withdraw funds up to your credit limit using dedicated checks or a linked card.
HELOCs have either variable or fixed interest rates. Variable means the interest rate can fluctuate over time based on changes in a benchmark interest rate, such as the prime rate. Fixed interest rates are the same throughout the duration of the loan. The interest rate influences your monthly payments.
2. The Repayment Period
After the draw period ends, you enter the repayment period. This can last another 10 years. During this phase, you'll repay the principal amount borrowed along with interest. At this time, you will no longer be allowed to draw from the account.
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The Pros and Cons of a HELOC
As with all financial offers, there are potential advantages and drawbacks with HELOCs. So, before you go all in, it’s important to understand both the positives and the negatives.
The pros of a HELOC are:
- You can access funds as needed up to your credit limit during the draw period, providing flexibility for various expenses or projects.
- Generally, HELOCs offer lower interest rates compared to credit cards or personal loans, making them a cost-effective borrowing option.
- In some cases, the interest paid on a HELOC may be tax-deductible if the funds are used for home improvements. Consult with a tax advisor for specific eligibility.
- Similar to a credit card, a HELOC is a revolving line of credit, allowing you to borrow, repay, and borrow again without reapplying.
- HELOCs often have higher credit limits compared to credit cards or personal loans, providing access to substantial funds based on home equity.
The Cons of a HELOC are:
- HELOCs can have variable or fixed interest rates. Variable means your monthly payments can fluctuate based on market conditions. Variable interest can increase payments if interest rates rise.
- Your home serves as collateral for a HELOC, so failure to repay can lead to the loss of your home.
- HELOCs may come with fees. This can include application fees, closing costs, annual fees, and early termination fees. These can add to the overall borrowing cost.
- The flexibility of a HELOC can lead to overspending or accumulating debt if not managed responsibly.
- After the draw period ends, you'll enter the repayment period where you must start repaying both principal and interest. This can increase monthly payments significantly compared to the interest-only payments you make during the draw period.
Think about your goals, your financial situation, and your ability to repay a HELOC as you consider the pros and cons.
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Let Centier Help You Decide if a HELOC is Right for You
Before you apply, carefully consider the advantages and disadvantages. Take a close look at your financial situation, borrowing needs, and risk tolerance.
Moving forward. here are some factors to consider:
- Do you have a steady income to support the payments?
- What do you plan to use the funds for? Is it a wise investment in your future?
- Are interest rates favorable for HELOCs currently?
- Can you comfortably manage the potential payments?
A HELOC can offer flexibility and convenience when you need access to funds for ongoing expenses or major purchases. However, it's crucial to carefully consider the terms, interest rates, fees, and risks.
If this sounds like the right financing option for you,explore Centier Bank’s HELOC rates and apply today.
Sources:
[1] https://www.hud.gov/program_offices/fair_housing_equal_opp/fair_lending
[2] https://selling-guide.fanniemae.com/sel/b2-1.2-03/home-equity-combined-loan-value-hcltv-ratios
[3] hhttps://myhome.freddiemac.com/refinancing/options-for-refinancing
