Home equity lines of credit: Unlocking buying power with HELOCs

What is a HELOC?

A home equity line of credit (or HELOC) allows you to use the equity of your home and borrow against its value. With this type of loan, you are essentially using your house as a credit card. It’s a powerful borrowing option since homes are high-value assets.

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Home equity is the amount of your home that you own based on how much of your mortgage has been paid. To calculate your home equity, you’ll need to gather:

• Your mortgage balance (the amount of money you still have to pay back on your loans)
• Your home’s appraised value

Once you have these numbers, subtract your home’s appraised value from your mortgage balance. This will give you your home equity.

Let’s pretend your home was valued at $500,000 and your mortgage balance is $100,000. You would have to calculate:

• $500,000 – $100,000 = $400,000

This means that you would have $400,000 of equity in your home.

How does a HELOC work?

With a HELOC, you are giving a bank or lender temporary equity in your home. You can borrow as much money as you need from the percentage of equity. With a HELOC, you typically have a 10-year draw period, meaning you have ten years to withdraw the money. During the draw period, you make monthly payments for just the interest on the loan. Once the draw period ends, you must repay the full balance. Those who get a HELOC typically have 10 to 20 years to repay the balance as well as interest.

The amount that you are allowed to borrow will depend on how much home equity you have. Your home’s value and how much of your mortgage you must repay will also affect how much you can borrow. Typically, homeowners can borrow up to 85% of their home’s value, minus the amount they owe on the house. Your credit score will also affect the amount that you can borrow.

Let’s say you are interested in a home equity line of credit and your home is valued at $700,000, but you have $200,000 remaining to pay on your mortgage. You qualify for a HELOC that is 80% of your home’s value, which is $560,000. Subtract $560,000 from the amount you still owe on the home ($200,000) and you’ll arrive at your credit limit, which is $360,000.

What can you use a HELOC for?

HELOCs are typically used to help fund large purchases or expenses. HELOCs are often used for home renovations because homeowners can use their home’s current value to increase its value through home improvements. They can also be used to purchase a second home, like a vacation home or an investment property. Some also use HELOCs to pay for a college education since the interest rate you’ll get through a home equity line of credit is much lower than student loan interest rates. HELOCs may also be used to pay off other debts like credit card loans or for emergency expenses, such as sudden medical bills.

Cons of a HELOC

The main downside of obtaining a home equity line of credit is that you could lose your home. If you cannot repay the money you borrowed, your HELOC lender may foreclose your home in order to get their money back.

Another downside of HELOC loans is that it’s easy for borrowers to spend more than they intended. Since borrowers only must pay low-interest fees during the draw period, it can lead to reckless spending. It’s also important to note that HELOCs have variable interest rates, meaning the interest you owe can change at any time.

How to get a HELOC

In order to qualify for a HELOC, you typically need at least 15% to 20% equity in your home. You’ll also need a good credit score – most lenders prefer borrowers to have a credit score of at least 700, but this will vary depending on the borrower. Lenders will also look at your debt-to-income ratio and prefer borrowers to have a debt-to-income ratio below 50%.

When you’re ready, see what HELOC your bank offers, but don’t stop there. It’s important to compare different home equity lines of credit across different banks and lenders to make sure you are choosing an option that is right for you.

Getting a HELOC is a powerful way to access extra cash. Now that you know more about HELOCs, you can confidently choose the right one for your household.