HELOC loan, or home equity line of credit, allows you ― a homeowner ― to tap into the equity you’ve built over time. This flexible second mortgage lets you secure a low-cost revolving loan backed by the value of your home. You get a credit limit based on how much equity you have. You can borrow as much or as little as you need, meaning you only pay interest on what you actually draw.

If you’re considering a HELOC, we’ll explain the specifics of the loan, including how they work and their benefits and drawbacks. We’ll also share some tips to help you figure out if this type of loan is right for you and whether a loan through RenoFi is a suitable alternative.

What Is a HELOC?

A HELOC is a type of loan where homeowners can borrow money using the equity in their homes as collateral. Equity is the difference between the value of your home and what you still owe on your mortgage. You can use a HELOC for major expenses, such as making substantial renovations to your home, paying for college, or consolidating high-interest debt.

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How Do HELOCs Work?

Once you get approved for a HELOC, you’ll have a credit limit based on how much equity you have in your home. During what’s called the draw period — usually about 10 years — you can use the money whenever you need it. You might get checks or a card to spend it, or you can transfer funds online. Each month, you’ll pay just the interest on what you’ve borrowed. As you pay back what you owe, that money becomes available to borrow again.

After the draw period ends, you’ll enter the repayment period. During this time, you can’t borrow more money, and you’ll start paying off what you owe plus interest. Most plans give you 10 to 20 years to pay it all back.

While you only have to pay interest during the draw period, you can pay both the money you borrowed and the interest if you want to. That can help you keep your payments steady when you start repaying the loan.

How Much Credit Can You Get With a HELOC?

The amount of credit you can get with a HELOC comes down to factors such as the equity you have in your home, your credit score, and your income. Higher credit scores and stable incomes can help you get a larger line of credit. Usually, lenders will let you borrow around 80% to 85% of your home’s value minus what you still owe on your mortgage.

For example, if your home is worth $400,000 and you still owe $200,000 on your mortgage, you have $200,000 in equity. If a lender lets you borrow up to 85% of your home’s value, you could qualify for a HELOC of up to $140,000. To calculate this, take 85% of your home’s current value and subtract what you still owe on your mortgage ($400,000 x 85% = $340,000 - $200,000 mortgage = $140,000).

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Benefits of RenoFi Loans

While a traditional 85% LTV HELOC may be a viable option to fund a home renovation project for some, it often isn’t enough unless you have built a lot of equity in your home. That’s because a traditional HELOC is based on the current home value. RenoFi loans are different - they use the after renovation value of the home, which in turn greatly increases the available equity and your borrowing power.

For example, imagine your home is currently valued at $500,000 and your outstanding mortgage balance is $400,000. You are planning a renovation and expect that the after renovation value of your home would be approximately $640,000. 

Your current loan-to-value ratio (LTV) is at 80%, which means that you effectively can’t borrow anything to fund your renovation because most lenders limit home owners to a max of 80% LTV. 

A RenoFi loan would determine the maximum borrowing power using the lower of: 

  • 150% LTV
  • 90% LTV using the after renovation value 

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 the after renovation value of your home! 

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 here. 

What Are HELOC Interest Rates?

HELOCs usually come with variable interest rates, meaning the amount you pay in interest can change from one month to the next. Lenders calculate your HELOC rate every month based on the following:

The Index

This is the starting rate set by the market that your lender uses to calculate your HELOC rate. Different lenders may set their own prime rates based on how they view the market. Many use standard rates such as the Constant Maturity Treasury (CMT) or the U.S. prime rate.

The Margin

This is an extra amount added to the index to determine your interest rate. Your lender looks at your specific financial details, like your credit score and how much you want to borrow, to decide how much margin to add. The difference between the market rate and what you pay is how lenders make money from a HELOC.

The Ceiling

This sets the highest limit on how much your interest rate can go up during your loan term. Different lenders have their own ceiling, but federal credit unions can’t charge more than 18%.

Although this up and down in interest rate calculation might make budgeting a bit tricky, the good news is that your lender is required to let you know how the adjustments in rates are calculated.

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Is There a Fixed-Rate HELOC Option?

You can find fixed-rate HELOCs at RenoFi, but they’re not as common elsewhere. With these, you can convert a portion of your credit line to a fixed interest rate. You still have the flexibility to borrow as you need, but having a fixed rate protects you from potential rate increases for a set period.

Is HELOC Interest Tax Deductible?

Yes, you can deduct HELOC interest on your taxes under the current tax rules. If you itemize deductions and meet the requirements, you can write off part of the interest you pay on your HELOC.

Currently, if you file taxes together with your spouse, you can deduct the interest on up to $750,000 of mortgage debt (or $375,000 if you file separately). This is as long as the money was used to:

To deduct HELOC interest, the funds must be used to:

  • Improve your primary or secondary residence
  • Buy your primary or secondary residence
  • Refinance an existing mortgage where the funds are used to substantially improve the home

If you use the HELOC for other purposes, such as consolidating debt or paying for college tuition, the interest isn’t deductible under the current rules. Tax laws can change, so it’s a good idea to check in with a tax advisor who can give you advice based on your situation and the latest rules.

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How Do You Qualify for a HELOC Loan?

Although different lenders have their own specific requirements, here are the common criteria you need to meet to qualify for a HELOC:

  • Enough Home Equity: You should have a good amount of equity in your home, which means the value of your home minus what you still owe on your mortgage. Usually, you’ll need at least 15% to 20% equity.
  • Good Credit Score: Lenders prefer a solid credit score, usually around 680 or higher. A higher score can help you get approved and possibly get lower interest rates.
  • Low Debt-to-Income (DTI) Ratio: Your DTI ratio should be low, ideally 43% or less. This shows you can handle your debt responsibly alongside a HELOC.

Pros and Cons of a HELOC Loan

Pros

  • Possible Lower Interest Rates: HELOCs usually have lower interest rates than credit cards or personal loans. Because they’re backed by your home, lenders are more willing to give you a better rate.
  • Easy Access to Funds: With a HELOC, you have a credit line you can dip into whenever you need, up to the limit of your HELOC. This flexibility is great for covering expenses where it’s hard to predict costs.
  • Potential Boost to Credit Score: HELOCs can help improve your credit score over time if you manage the loan responsibly.
  • Possible Tax Benefits: You might be able to deduct the interest on your HELOC from your taxes if you use it to improve your home.
  • Many Possible Uses: You can use a HELOC for lots of things, such as consolidating debt, paying for school, or handling emergencies.

Cons

  • Risk of Borrowing Too Much: HELOCs let you borrow, pay back, and borrow again during the draw period. It’s easy to keep borrowing until you’re in over your head, especially when it’s time to start paying it all back.
  • Closing Costs and Fees: HELOCs come with various fees that can add up quickly, so it’s smart to read the fine print.
  • Variable Interest Rates: HELOCs usually have interest rates that can go up and down depending on market conditions. This means your payments might increase unexpectedly. This can disrupt your budget, as it’s hard to plan when you’re not sure what you’ll owe each month.
  • Risk of Losing Your Home: Since your house is used as collateral, not being able to keep up with payments could mean losing it.
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How to Get a HELOC Loan

Getting a HELOC is kind of like applying for a mortgage. Here’s what you need to do:

1. Decide if a HELOC Is Right for You

Figure out if a HELOC works for your needs, especially if you need regular access to cash for things like home improvements or medical bills. Compare it with other options, such as home equity loans or cash-out refinancing, and make sure you have a plan to pay back what you borrow.

2. Get Your Documents Together

Gather your documents, including recent pay stubs, W-2 forms, mortgage statements, and ID. The application process is much easier with these handy.

3. Apply With a Few Lenders

Shop around and apply with different lenders to see who offers the best rates, fees, and terms. You can apply with several HELOC lenders within 45 days without affecting your credit any more than applying with just one.

4. Compare Offers

Look at the offers you get and compare them carefully. Check out the total costs, including interest rates and fees. Remember to look at how flexible the HELOC terms are.

5. Close the Deal

Once you’ve picked the option that best suits you, go through the closing process. You’ll sign some papers and be ready to pay closing costs, which could be 2% to 5% of the credit line amount.

Should You Take Out a Home Equity Loan Instead of a HELOC?

Well, it all comes down to what you need and how your finances look. A HELOC allows you to borrow money against the value you’ve built up in your home. You can take out money (up to a limit) as you need it.

On the other hand, a home equity loan gives you a lump sum upfront that you pay back over time, similar to a regular loan.

HELOCs usually come with variable interest rates, which means your payments could go up if rates rise. Home equity loans have a fixed interest rate, which can protect you from unexpected increases in your payments.

To figure out which one’s right for you, talk it over with your lender. They can help you choose the option that fits your financial situation best.

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Tips on How to Shop for a HELOC Loan

No matter the type of loan you opt for, it’s super important to shop around for the best — or at least the most favorable — deal. Remember, a HELOC loan can vary significantly between lenders, so make sure you get quotes from at least three lenders before you decide.

Credit unions and small community banks can give you great deals if you’re looking to borrow under $100,000. For larger loans (around $1500,000 and up), national banks and mortgage brokers are your best bet.

A licensed mortgage broker, like RenoFi, has long-standing relationships with several reputable lenders. They can help you find a lender that understands your mortgage needs.

One more thing: Look beyond interest rates when shopping for a HELOC. Choosing a lender solely based on low interest rates may lead to unexpected fees or restrictions that could end up costing you more in the long run.

Before you decide on a lender, make sure to consider the overall terms, including closing costs, annual fees, and repayment conditions. This will give you a clearer picture of the total cost of the loan so you can make a well-informed decision.

Tap Into Your Home’s Equity With a RenoFi HELOC

The more equity you’ve built up, the more cash you can get with a HELOC loan. But even if you don’t have a lot of equity, RenoFi’s unique offer can help. With a RenoFi HELOC, you can actually borrow more than a traditional one would allow. This option lets you take out up to 125% of your home’s future value after renovation, even before you start renovating. In other words, you can secure a loan based on what your home will be worth once the upgrades are finished.

If you’re planning to make some improvements to your home, RenoFi loans are the smartest way to finance a home renovation project. Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the After Renovation Value of your home. This allows you to borrow on average 11x more, get a low monthly payment, and keep your low rate on your first mortgage. 

Don’t hesitate to reach out if you’d like to learn more about the RenoFi HELOC or have any questions about using your home equity for improvements.

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By RenoFi Team Our dedicated team of Renovation Advisors, Loan Officers, and experts oversees our entire content production process to ensure it provides a high-level of authority and benefit to our website visitors. While all content has been thoroughly proofread and fact-checked to publication, we advise that it should be consumed for general informational purposes only.

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