A home equity line of credit (HELOC) is a type of revolving credit that allows you to borrow funds against the value of your home. If you’ve paid off a significant portion of your mortgage, applying for this type of loan can be advantageous as you can use your available equity to access cash from a lender. The maximum amount you can borrow will depend on your home’s current appraised value, the amount of equity you’ve built up, and the percentage of this equity your lender is willing to loan you.
Once you secure a home equity line of credit, you can make purchases up to your credit limit and repay the balance and interest over a given period. In this way, HELOCs are like a credit card. However, a HELOC will expose you to more risk than the average credit card, given that the line of credit is secured using your home as collateral.
While HELOCs can be a flexible financial tool, it’s crucial to understand all the ins and outs before you apply. From how to calculate your home equity to the percentage lenders will allow you to borrow, there are several factors to consider while making your decision. Keep reading to learn more about this type of revolving credit.
What is a HELOC?
HELOCs are a type of second mortgage that enables homeowners to tap into their home equity to access cash and cover significant expenses. You can use your HELOC to make home improvements, renovate your house, send your kids to college, pay off sudden medical expenses, or even take a family vacation. You can also borrow, repay, and then borrow again as you need.
A HELOC often comes with a competitive interest rate because you secure it against your home. But remember, HELOCs also use your home's equity as collateral, raising the stakes if you cannot repay your debt in the future. In a worst-case scenario, your lender could force you into foreclosure if you default on your HELOC.
A home equity line of credit consists of two primary phases: the draw and repayment periods.
- Draw period: During this initial phase of a HELOC, you can withdraw funds up to your approved credit limit and are only required to make interest payments. The draw period typically lasts about ten years.
- Repayment period: The repayment phase begins once your 10-year draw period ends. During this phase, you cannot withdraw additional funds. You must also start making monthly payments to cover the principal and interest of your debt. This repayment period typically lasts about 20 years.
If you fail to pay off the total balance of your HELOC during the repayment period, your lender can initiate foreclosure proceedings on your home. Your credit score will also likely take a hit, making it more challenging to open a line of credit in the future.
HELOC interest rates
HELOC interest rates will vary by lender. However, your lender's annual percentage rate will often largely depend on your credit score, existing debt, and the total amount you want to borrow.
When you apply for a HELOC, your lender will consider your financial profile and offer a specific borrowing rate. The lender will determine what rate they can give you by calculating a borrowing margin based on your financial situation and applying this margin to their prime rate (the lowest rate they’re willing to give to the most attractive borrowers).
Most HELOC rates are adjustable, meaning they adjust as baseline interest rates fluctuate. However, because you secure the line of credit with your home as collateral, HELOC interest rates are usually lower than credit cards or personal loan rates.
What are the requirements for a HELOC?
Exact HELOC requirements will vary by lender, but here’s what your financial situation typically has to look like to get a home equity line of credit:
- Debt-to-income ratio: 40% or less
- Credit score: 620 or higher
- Home value: 15% or more than you owe
How Much Can You Borrow With a HELOC?
The maximum amount you can borrow with a HELOC will depend on two main factors: your equity and the percentage your lender will allow you to borrow. With just two straightforward calculations, you can get a general idea of how much you’ll be able to borrow.
How to calculate the maximum HELOC you can borrow
To calculate the maximum amount you can borrow, you’ll need to know your home’s appraised value, the current balance on your home’s mortgage, and the maximum percentage your lender will allow you to borrow. 80% to 90% is the typical standard maximum for a HELOC, but different lenders may offer different borrowing percentages.
- Home’s appraised value: $600,000
- Maximum percentage offered by your lender: 85%
- Total mortgage balance: $3,000
Once you know these values, the actual calculations are straightforward if you follow the correct equations. Start by taking your home’s value and multiplying it by the maximum percentage your lender offered.
For example, say your home is worth $600,000, and your lender offers a maximum HELOC percentage of 85%. The maximum amount you could borrow would be $510,000.
Maximum amount you can borrow = (Your home’s value) (Maximum borrowing percentage)
$510,000 = ($600,000) (.085)
Next, subtract the total balance left on your mortgage from the maximum amount you can borrow.
For example, if you owed $300,000 on your primary mortgage, the total amount you could borrow now would be $210,000.
Total amount you can borrow right now = Maximum amount you can borrow - Mortgage balance
$210,000 = $510,000 - $300,000
Is a HELOC a Good Idea?
HELOCs offer flexible borrowing terms, but they’re also risky. Determining if this type of loan is best for you will depend on your financial situation and future goals. Here are the pros and cons of a HELOC:
Pros of a HELOC
- Flexibility: HELOCs often allow homeowners to borrow large amounts and repay the balance over a long period, which can help fund home renovations and major repairs and subsequently increase your home’s value.
- Lower interest rates: HELOC lenders often offer lower rates to borrowers because they use the borrower’s home to secure the loan.
- Tax-deductible interest: In some scenarios, the interest you pay on your HELOC may be tax-deductible depending on how you plan to use the money.
Cons of a HELOC
- Collateral: When you apply for a HELOC, you’re putting your house on the line and increasing your risk of foreclosure.
- Diminished equity: Borrowing a HELOC will use up some or all of your home equity based on the amount you borrow.
- Varying rates and payments: Since most lenders only offer HELOCs with a variable interest rate, estimating your long-term financial commitment can be challenging. Depending on your financial situation, you may be better off getting a fixed-rate loan.
How to Get a HELOC
Applying for a HELOC is similar to the process for a standard mortgage. You’ll want to demonstrate to your lender that you’re financially responsible and that your credit score is excellent to get the best interest rate.
- Calculate your equity (your home’s appraised value - total mortgage balance owed).
- Determine how much you want to borrow.
- Gather financial documentation (W-2s, pay stubs, mortgage statements, etc.)
- Compare rates and terms with multiple lenders.
- Ask your lender questions to make sure the HELOC fits your needs.
- Complete the underwriting process.
- Close on your loan.
- Use your credit line.
Is a HELOC Right For You?
In conclusion, HELOCs offer homeowners a convenient way to access cash by leveraging their equity. The flexibility and low interest rates typically associated with a HELOC can make them an intriguing loan option. However, they also come with their risks, including the potential to lose your home if you default on your payments. Carefully weigh the pros and cons of a HELOC and ensure it aligns with your financial goals before signing the dotted line.
In addition to exploring financial options like a HELOC to enhance or renovate your current home, now might be the perfect time to consider moving to your dream property. At Century Communities, we design homes with every owner in mind, from modern features to spacious layouts that meet your unique needs. Explore dream homes in your area using our Find Your Home feature.
HELOC FAQ
How is a HELOC different from a second mortgage?
HELOCs are a type of second mortgage you can get by using your home equity. They offer a flexible line of credit that you secure by using your home as collateral. HELOCs can also serve as a primary mortgage if you’ve already paid off your home in full.
Home equity loan vs HELOC
The main difference between a home equity loan and a home equity line of credit is how lenders pay out the money. You’ll have to offer your home up as collateral to get both loan types, but a home equity loan is paid out in a lump sum, while a HELOC allows you to withdraw money as needed.
Can you refinance a HELOC?
Yes, you can refinance a HELOC, potentially lowering your monthly payment and making your outstanding balance easier to repay.
