HELOC

A HELOC or home equity line of credit is a flexible way for homeowners to borrow money based on their property’s value. If you’ve been consistent with your mortgage payments, you’ve likely built up equity in your home. A HELOC allows you to convert that equity into fast cash that you can use as needed.

However, as with any financial decision, it’s important to understand the key considerations and potential pitfalls before proceeding. This article explores what a HELOC is, how it works, its requirements, benefits, and everything in between to help you decide if it’s the right match for you.

What Is a HELOC?

Much like traditional credit cards, a Home Equity Line of Credit (HELOC) [link to HELOC Explained: How to Leverage Home Equity for Financial Flexibility] is a revolving credit with variable interest rates. However, instead of being tied to your creditworthiness alone, this line of credit is secured by the equity in your home. It allows you to borrow and repay funds on an as-needed basis.

Since your property backs the loan, making timely payments is important. Failing to do so could put your home at risk of foreclosure.

How Does a HELOC Work?

A HELOC lets you borrow against the equity in your home, giving you a credit limit based on that equity. Unlike a one-time upfront loan, a HELOC allows you to borrow in portions as required.

Draw Period

The draw period usually extends for around 10 years, during which you can borrow up to your credit limit. You’ll only be required to make monthly interest payments on the borrowed amount, and as you make repayments, those funds are replenished for future borrowing.

While you’re only required to pay interest during this period, you can also make principal payments. Doing so would help keep your payments more manageable in the long run.

Repayment Period

After the draw period ends, you enter the repayment period. During this phase, you no longer have access to borrow more funds. Instead, you’ll need to pay back the borrowed amount plus interest over a period of 10 to 20 years. By keeping up with your payments, you can ensure your financial well-being and avoid the risk of foreclosure.

How Much Can You Borrow?

HELOC loan limits differ among lenders and depend on the amount of equity you have in your home. Lenders use a combined loan-to-value (CLTV) ratio to determine how much you can borrow. This ratio compares the total value of all your loans secured by the home to the home’s appraised value.

Most lenders will allow you to borrow up to 80% of your home’s value. Some may even offer up to 90%.

However, RenoFi loans let you borrow based on what your home could be worth after renovations, not just its current value. This is especially helpful for new homeowners, as it often allows for higher borrowing limits. 

For example, if your home is valued at $500,000 and you owe $400,000 on your mortgage, you’re at an 80% loan-to-value (LTV) ratio, which limits how much you can borrow for renovations. With a RenoFi Loan, you can borrow based on the projected value after renovations. 

If you expect your home’s value to rise to $640,000, you might be able to borrow up to 150% LTV or 90% LTV of this new value, potentially accessing up to $176,000. This is a massive advantage over a traditional home equity loan, which wouldn’t offer additional funds.

So, in this example, while using a standard home equity loan results in your borrowing power being $0, a RenoFi loan allows you to borrow up to $176,000, thanks to your home’s after-renovation value!

If you are considering a home renovation, RenoFi is by far the smartest way to finance your project. Learn more and explore your borrowing options.

HELOC Requirements

HELOC eligibility requirements can differ by lender, but some common standards exist.

Adequate Equity in Your Home

Equity in your home plays a significant role in qualifying for a HELOC. Equity is the portion of your home you own outright without any mortgage balance or loan remaining. You will need at least 15% to 20% equity. Lenders will want to know what your place is worth and will likely send an appraiser to check it out.

Have Good Credit

Having good credit not only helps you qualify for a HELOC but also secures better interest rates. Generally, the higher your credit score, the lower your rates. Lenders often look for a score in the mid-to-high 600s – though a score of 700 or above is even more favorable.

Have a Low Amount of Debt

Your debt-to-income (DTI) ratio is another key qualifier. It refers to the ratio of monthly debt payments to monthly income. Assessing your DTI ratio helps lenders decide if you can handle more debt responsibly. Typically, a DTI ratio between 43% and 50% could help you qualify for a HELOC, though some lenders might require a lower ratio.

Show Sufficient Income and Documentation

Lenders want to ensure you’re a safe investment, so you must prove that you have enough income to repay. You must provide documentation showing your income and employment information to do this. Accompanying paperwork could include:

• Self-employment: Most recent federal tax returns
• Employee wages: Most recent pay stubs and forms
• Social Security and other benefits: 1099 forms, benefits statements, or retirement award letters.

How to Get a HELOC

Applying for a HELOC is easier than you might think. Follow these six simple steps to get started:

1. Decide How Much to Borrow: Estimate your home equity by checking recent sales of similar homes in your area. Subtract your current loan balance from your home’s estimated value to get a rough idea of your available equity. Lenders usually let you borrow 80% to 85% of your equity.
2. Compare Lenders: Don’t settle on the first offer. Look at different lenders and loan options, comparing interest rates, fees, and repayment terms.
3. Gather Financial Documents: Be prepared with your bank statements, recent tax returns, pay stubs, and documents showing your debt. You will also need your insurance policy, property tax bill, and latest mortgage statement.
4. Submit Your Loan Application: After choosing a lender, complete your loan application and provide any additional documents the lender requests.
5. Read the Fine Print: Review the loan disclosures before signing. These will include details about your repayment terms, APR, and how much and how often you can access funds.
6. Close on the Loan: Once you accept the loan terms, you will proceed with closing, which typically includes costs similar to those of a standard mortgage. Closing costs can range from 2% to 5% of the loan amount and may include expenses like title search fees, attorney fees, and appraisal fees.

The Pros and Cons of HELOC

Like any financing option, a HELOC has its own pros and cons. Let’s review the benefits and drawbacks so you can weigh the good against the bad and decide if it fits your needs correctly.

Pros of HELOCs

• Flexible terms: With a HELOC, you can borrow only what you need. For example, if you can access a $20,000 credit line but only need $10,000, you can leave the rest untouched, avoiding extra interest.
• Low-interest rates: Because your home serves as collateral, HELOCs generally offer lower interest rates compared to personal loans or credit cards, making them a more cost-effective option
• Tax-deductible: If you use your HELOC for home renovations, the interest could be tax-deductible, adding a nice bonus to your savings.
• No restrictions: You have the freedom to use the funds however you choose. However, it’s wise to have a clear plan for using and repaying the money before taking out a HELOC.

Cons of HELOCs

• Easy access to credit line: Quick access to funds can be a plus, but it also comes with risks. The convenience might tempt you to borrow more than you can comfortably repay, and it could take years to realize how much debt you’ve accumulated fully.
• Variable interest rates: Many HELOCs come with adjustable rates, which means your interest rate might increase over time. Even if your balance stays the same, your monthly payments could increase, making it harder to keep up.
• Reducing the equity in your home: Borrowing from your HELOC reduces the equity you’ve built up in your home. If the housing market declines, you could end up underwater, owing more on your home than it’s worth.
• Putting your home at risk: Since a HELOC is secured by your house, defaulting on your payments could lead to severe consequences, including losing your home.

How to Use Your HELOC

The best ways to use a HELOC are those that will generate income for you, like increasing your home’s value, boosting your business profits, or earning rental income from an investment property. Sometimes, it can also save you money, such as by lowering the interest you’re paying on outstanding debts.

Here are some common ways homeowners use HELOCs:

Home Improvements

Using a HELOC for home improvements can be a wise decision. Whether you’re upgrading your kitchen, adding a new bathroom, or finishing your basement, these projects can increase the price of your home and make it more comfortable to live in. Particular home renovations might make you eligible for tax benefits, adding even more value to your investment.

Emergency Bills

Life can throw unexpected expenses your way, like medical emergencies or urgent home repairs. A HELOC can provide quick access to funds when you need them most, helping you cover these unexpected costs without turning to high-interest credit cards or personal loans.

Debt Consolidation

If you’re juggling multiple high-interest debts, like credit card balances or personal loans, a HELOC can help you streamline those payments. By using your HELOC to pay off these debts, you can reduce the interest you’re paying and simplify your finances.

If You Can’t Pay Back Your HELOC

If you cannot repay your HELOC, it doesn’t automatically mean you will lose your home. However, even if you avoid foreclosure, significant financial repercussions can still be.

Most lenders are willing to work with borrowers struggling to make payments, so it’s crucial to contact your lender as soon as possible. Ignoring the issue will only make things worse in the future.

Some lenders may offer to modify your loan or line of credit. This could include changes to the monthly payments, interest rate, loan term, or a combination. While extending the loan term can lower your monthly payments, it might mean paying more in the end.

Alternatives to HELOC

A HELOC can be great for some borrowers, but it’s not your only choice. Here are a few other alternatives to consider:

HELOC vs. Home Equity Loan

HELOCs and home equity loans [link to Home Equity Loans: Getting the Most Out of Your Loan]  let you access your home’s value, but they differ in critical ways. A HELOC works like a credit card, offering a revolving line of credit with typically variable interest rates. In contrast, a home equity loan acts more like a second mortgage, giving you a lump sum of cash with a set interest rate.

HELOC vs. Cash-Out Refinance

A cash-out refinance replaces your current mortgage with a larger loan. The extra amount you borrow is given to you in a lump sum. The main difference between a cash-out refinance and a HELOC is that a cash-out refinance changes your existing mortgage, while a HELOC adds a new line of credit on top of your current mortgage, leaving it unchanged.

HELOC vs. Personal Loan

Personal loans generally have higher interest rates than home equity loans but don’t require your home as collateral. Personal loans offer fixed interest rates and provide funds in a single payment like home equity loans.

HELOC vs. Reverse Mortgage

A reverse mortgage lets you access your home equity with no repayment required until you move out. However, they often come with high fees and accrue variable interest on the money you receive. Reverse mortgages are primarily available only to older homeowners (62 or older for Home Equity Conversion Mortgages or 55 and older for some proprietary ones).

Conclusion

HELOC loans offer an easy way to tap into the hard-earned equity you’ve built in your home. However, if you’re a recent buyer who hasn’t had time to accumulate equity yet, a RenoFi HELOC might be a more suitable choice.

RenoFi Loans are unique because they’re based on your home’s future value after renovations, not just its current value. This means you could get up to 11 times more borrowing capacity, enjoy lower monthly payments, and keep your original mortgage rate. 

So, while traditional home equity loans depend on your current home value, RenoFi Loans use the future value to boost your borrowing power—ideal for new buyers or those with less ownership. Just remember, increased property value isn’t guaranteed, so it’s essential to consider your finances carefully.

Start your RenoFi loan application today and determine your borrowing limit without impacting your current mortgage rate.