What is a Home Equity Line of Credit (HELOC)?
An Essential Property Management Term
A home equity line of credit, or HELOC, is a form of revolving funds that allows you to borrow money against your home’s value over time. It’s secured using your home’s value as collateral, giving you access to cash as needed. A HELOC is more like a second mortgage and less like a home equity loan. It gives you a revolving credit line similar to a credit card, based on your home equity (current home value minus the mortgage). In contrast, home equity loans offer a fixed lump sum based on home value.
How a Home Equity Line of Credit (HELOC) Works
A HELOC works like a typical credit card, allowing individuals to borrow as per their spending limits as many times as necessary. Therefore, a HELOC will enable people to borrow money against their available home equity, repay it, and borrow again.
HELOCs have higher credit limits and more attractive interest rates than credit cards because they are secured using an asset. The rates are slightly higher than for mortgages and lower than for credit cards. HELOCs rarely come with an origination fee, making them easy to acquire.
How a HELOC is Calculated
HELOCs are mainly calculated based on the available home equity. Equity is calculated using the value of the home estimate minus any existing mortgages, home equity loans, and other HELOCs. Qualified borrowers are in a position to borrow up to 85% of their home value. HELOC rates are set based on an index rate plus a markup based on the borrower’s credit profile. Individuals with higher credit scores often get lower markups.
How to Qualify For a HELOC
The qualifications for getting a HELOC might change depending on your circumstances. However, the universal qualifications include:
- A debt-to-income ratio of 40% or below
- A credit score of at least 620.
- The home’s value should be 15% more than what a borrower owes. Available home equity limits can be calculated using a HELOC calculator.
How is a HELOC Repaid?
HELOCs have a draw period and a repayment period. The draw period is the time when a borrower can get money from this credit line. The period might vary, but it often lasts for about 10 years. During this time, the borrower is obligated to make minimal interest-only repayments.
The repayment period is when the credit line is no longer available, after which monthly repayments will include both interest and principal. For individuals who make interest-only payments during the draw period, the monthly payments might increase significantly during the repayment period. The length of this period varies, but it is often 20 years.
Is a Home Equity Line of Credit (HELOC) a Good Credit Option?
A HELOC’s validity mainly depends on the borrower’s financial profile. HELOCs are good when used for renovations and home repairs that increase the home’s value. Interest payments on HELOCs can be tax-deductible. Overall, HELOCs are a good idea when they are spent on ventures that build wealth, such as purchasing additional investment real estate.
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