HELOC terms are important to know as a homeowner. A home equity line of credit (HELOC) is an excellent financing option for homeowners who need to leverage their homes’ equity for renovations, debt consolidation, and other major expenses.
In this guide, we cover the essential aspects of HELOC terms, helping homeowners make informed decisions about the financial options available to them.
What Exactly Is a HELOC?
A HELOC is a loan that allows homeowners to borrow against the equity of their homes. This type of loan usually goes as high as 85% of the home’s value minus what is owed on the mortgage. Unlike a traditional loan, a HELOC functions much like a credit card, allowing you to withdraw funds as needed up to a certain limit, repay the borrowed amount, and borrow again.
10 Key HELOC Terms Every Homeowner Should Know
To understand how any HELOC works, you must get familiar with the key terms that define the structure and costs of the loan. Below are some of the most important HELOC terms that will guide homeowners through the process.
1. Loan-to-Value (LTV) Ratio
The loan-to-value ratio (LTV) is one of the most critical factors in determining how much you can borrow with a HELOC. In simple terms, LTV refers to the ratio of the current balance on your mortgage compared to the current market value of your home. Most HELOC lenders typically allow a maximum LTV of 85%, but this varies from one lender to another.
2. Draw Period
The draw period is the duration during which you can borrow from the available line of credit that your HELOC affords you. This period usually lasts between 5 and 10 years, but it’s not uncommon for some lenders to offer longer terms.
During the draw period, you only need to make interest payments on the amount borrowed, but you may also pay down the principle if you wish.
Once the draw period ends, you will be unable to borrow additional funds. This is when your repayment period begins, which brings us to the next crucial term—the repayment period.
3. Repayment Period
The repayment period is just as important as the draw period. After the draw period ends, you then enter the repayment period, which usually lasts for 10 to 20 years after the draw period.
During this period, you can no longer borrow from your credit line, and you are required to start making payments that count toward both your principal and interest.
The monthly payments you incur during the repayment period are usually higher than the amount paid during the draw period since you are now paying off the loan itself and the interest.
4. Interest Rate
HELOCs commonly have variable interest rates, which means the rate can change depending on the price fluctuation that occurs in the broader housing market. This makes HELOCs a slightly more risky type of loan compared to fixed-rate loans, as your payments could potentially increase if interest rates rise.
Some lenders may opt for the prime rate as the base rate for determining the interest on a HELOC, while others may offer fixed-rate options within a HELOC for borrowers who prefer predictable payments.
5. Annual Percentage Rate (APR)
The annual percentage rate (APR) is a broader measure of the cost of borrowing. It includes the interest rate and other costs like closing fees, application fees, and maintenance fees. You examine the APR of a HELOC for a more accurate picture of what the loan will actually cost over time.
6. Minimum Draw Amount
Some lenders may impose a minimum draw amount, mandating that you withdraw a certain minimum sum after your HELOC is approved. This amount can range from a few hundred to several thousand dollars. This is usually not a concern for larger projects HELOCs, but it might be worth noting for smaller projects.
7. Maintenance Fees
Some HELOC agreements may include maintenance or inactivity fees. These are small fees typically charged annually or monthly if you don’t use your line of credit. These fees are usually not high but they can add up over time.
8. Early Termination Fee
Some HELOCs may come with early termination or prepayment penalty. Essentially, this is the amount charged for closing your HELOC before a specific time, which is typically within the first three to five years.
9. Credit Score Requirements
Most lenders typically require homeowners to possess a credit score of at least 620 before they can access a HELOC. Higher credit scores usually equal lower interest rates and better loan terms.
10. Debt-to-Income Ratio (DTI)
Most lenders prefer that your debt-to-income (DTI) ratio be below 43%, and this means that not more than 43% of your gross monthly income should go towards paying debts, and this includes your mortgage and other loans.
RenoFi: A Smart Option for Home Renovation Loans
While a HELOC is a popular option for accessing home equity, it may not always be the best for your renovation needs, especially large-scale ones. HELOCs also don’t work well when your current home equity is limited.
RenoFi offers an innovative solution that could be more advantageous to you than a traditional HELOC.
A RenoFi loan uses the after-renovation value (ARV) of your home, which simply means the loan will be calculated based on the expected value of your home post-renovation. This allows you to borrow more money than you would be able to with a traditional HELOC or home equity loan.
Let’s imagine you want to borrow $150,000 for renovations to increase the value of your home by $150,000:
Scenario 1 (New Home Purchase):
- Home price: $600,000
- Downpayment (20%): $120,000
- Current Mortgage Amount: $480,000
Example Home Equity Line of Credit Amount:
- $600,000 * 80% = $480,000 (80% of Total Home Value)
- $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Line of Credit Amount)
Example RenoFi Home Equity Line of Credit Amount:
Assuming that your renovation project will add $150,000 to your home value
After Renovation Value of Your Home: $750,000
RenoFi Loan Amount:
- $750,000 * 90% = $675,000 (90% of Total Home Value)
- $675,000 - $480,000 = $195,000 (RenoFi Home Equity Line of Credit Amount)
Using a RenoFi Home Equity Line of Credit you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).
RenoFi HELOCs provide a line of credit secured by your current home.
Example RenoFi HELOC Terms:
Years to use credit line: 10 Years
- Interest Only Period: 10 Years
Credit Amount: $195,000
Repayment Term: 15 years
In this example, you’ll have 10 years to use your credit of $195,000. Within those 10 years, just like a credit card, if you borrow against the credit line and pay it back, you will not pay interest.
However, for anything borrowed against your credit, that you do not pay off immediately, you will only pay interest during the first 10 years and then interest and principal after year 10.
Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:
- Home price: $600,000
- Current Mortgage Amount: $420,000
Example Home Equity Line of Credit Amount:
Example Home Equity Line of Credit % of Home Price: 80%
Example Home Equity Line of Credit Amount:
- $600,000 * 80% = $480,000 (80% of Total Home Value)
- $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Line of Credit Amount)
Example RenoFi Home Equity Line of Credit Amount:
Assuming that your renovation project will add $150,000 to your home value
After Renovation Value of Your Home: $750,000
RenoFi Loan Amount:
- $750,000 * 90% = $675,000 (90% of Total Home Value)
- $675,000 - $420,000 = $255,000 (RenoFi Home Equity Line of Credit Amount)
Using a RenoFi Home Equity Line of Credit you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value).
In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:
- No draw periods
- No inspections
- No need to give up your original loan
- Higher borrowing limits
Is a HELOC Right for You?
Any homeowner considering a HELOC must have an adequate understanding of its terms and conditions. While traditional HELOCs offer flexibility and the ability to borrow funds as needed, they come with a few peculiar risks, especially due to variable interest rates and the potential for rising payments during the repayment period.
However, if you plan to carry out a significant home renovation and would like to maximize your borrowing potential, RenoFi loans offer a better solution by leveraging the after-renovation value of your home. With this option, you have access to greater borrowing power and fewer restrictions compared to a traditional HELOC.
Here’s why more people are turning to RenoFi:
- Increased Borrowing Power: Traditional loans often limit you to borrowing up to 80% of your current home value. Alternatively, RenoFi allows you to borrow up to 125% of your home’s current value or 90% of its future value, whichever is lower. This means more money for your renovation project without the need to refinance.
- No Need to Refinance: With RenoFi loans, you can keep your existing mortgage and its low rate intact while accessing funds for your renovation. This is a huge benefit if you’re locked into a favorable rate and don’t want to refinance.
- Streamlined Process: Unlike other loans, RenoFi loans don’t require complicated draw schedules and inspections. This makes it easier to start and complete your project on time.
Conclusion
Choosing the right home renovation loan can make or break your project. While traditional loans like HELOCs, personal, and FHA 203(k) loans have their place, they often come with limitations that can restrict your renovation plans. But RenoFi loans give homeowners a unique and flexible alternative.
By leveraging your home’s after-renovation value, RenoFi allows you to borrow more without the need to refinance your existing mortgage or deal with complex draw schedules and inspections. Therefore, if you are a homeowner looking to maximize your renovation potential, RenoFi loans are the best choice.
Unlike traditional loans, which are based on your current home value or require you to refinance, 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.
Explore your RenoFi loan options here.
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