Here’s what you need to know about taking out a HELOC
What is a home equity line of credit (HELOC)?
One of the most valuable benefits of homeownership is the ability to borrow against the equity you build up in your home over time. Many people turn to borrowing options, such as taking out a home equity line of credit (HELOC) to help cover large expenses like home improvements or education costs. Read on to learn how HELOCs work and what to know before making a decision.
What is a HELOC?
A home equity line of credit, or HELOC, is a revolving line of credit available to you based on the equity you have in your home. HELOCs may have lower interest rates than other loans, and the interest you pay may be tax-deductible when used to substantially improve your home.
How does a HELOC work?
Not to be confused with a home equity loan, a HELOC lets you borrow against the available equity in your home up to your credit limit. You can use your line of credit as often as you want throughout your borrowing period (or draw period), which is usually 10 years.
When do I have to pay back a HELOC?
When using your HELOC, you’ll receive a monthly bill for your minimum payment. Some lenders only require interest payments during the borrowing period. Others have you pay principal and interest, which may help keep your payments more consistent over time. The amount due may change based on your balance and interest rate fluctuations. Making extra principal payments helps you pay less interest and reduces your overall debt more quickly. Like a credit card, as you repay your outstanding balance, the amount of available credit is replenished. At the end of your borrowing period is the repayment period. During this time (usually around 20 years), you can no longer take out money and you must pay off what you owe.
What are the risks of a HELOC?
When you take out a HELOC, your home equity acts as collateral for the loan. This means that if you default, the lender could foreclose on your home, so it’s important to carefully consider what you’re borrowing for and make sure you have a plan to pay it off.
How do you qualify for a HELOC?
To qualify for a HELOC, you need to have enough equity in your home. Typically, you can borrow up to 85 percent of your home’s appraised value minus what you still owe on your mortgage or other loans secured by your home. Your lender will look at your credit score and history, employment history, monthly income and monthly debts. A better credit score improves your chances of qualifying and could lower the interest rates you’ll receive.
Quick tip:
Ask your lender what fees might come with your HELOC, such as an application fee, an annual fee, closing costs and a cancellation or early closure fee.
What is a variable interest rate?
When your HELOC has a variable interest rate, it can change from month to month. That’s because the rate is calculated on an ongoing basis using an index and a margin.
An index is a financial indicator that banks use to set rates on many consumer loans. Most banks use The Wall Street Journal prime rate as the index for HELOCs. The index, and consequently your HELOC interest rate and required payment, can move up or down.
A margin is the number of percentage points added to the index by your lender, and it remains constant throughout the life of the line of credit.
What’s a fixed-interest-rate option?
Some lenders allow borrowers to convert some or all of the outstanding variable-rate balance on a HELOC to a fixed rate. Payments are predictable, and this option can protect you from rising interest rates. Fixed interest rates on a HELOC are typically higher than variable HELOC rates.
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Credit and collateral are subject to approval. Terms and conditions apply. This is not a commitment to lend. Programs, rates, terms and conditions are subject to change without notice.
