To assist in this regard, we’ll examine a Home Equity Line of Credit or more commonly referred to as a HELOC, simplifying the subject so you will have a full understanding of the HELOC itself, how it is different from a home equity loan and how you qualify for one.
The 101 on home equity lines of credit
1. Core Concept of HELOC
Home equity lines of credit, also referred to as a HELOC, have similar functionality to a credit card. A HELOC makes a specific amount of credit available on an as-needed basis for a limited term. It’s followed by a repayment period of up to 20 years, having an adjustable rate that changes with the market.
The value of a HELOC reflects the market value of the home. Generally speaking, it’s realistic to open a HELOC for up to 80% of the home’s value, minus the amount the owner still owes on their existing mortgage. That said, some lenders offer 100% financing for the complete value of the home, minus the mortgage.
2. Differentiate between HELOC and home equity loans
One similar-sounding but completely different way of making the most of the equity of your home is a home equity loan. Unlike HELOC, home equity loans do not let you to access your money as you want it, nor are you able to pay interest on only the amount you withdraw.
Some homeowners believe it is nice that home equity loans have a fixed interest rate and like the fact that monthly payments will be for the same amount of money for a predetermined time period. However, others are unsettled by the concept that home equity loans can come back to bite them if property values decline.
At the same time, HELOC allows more flexibility with payments, and you pay just interest on the amount of money you withdraw. In the same vein, however, because the HELOC choice is more flexible, you might discover your interest rates rising and falling with the market.
3. Examples of HELOC uses
A HELOC has multiple functions, and post-purchase, you should be aware of what you’re capable of using them for. The most favored options, including drawing money for home improvements and repairs. Renovations have the potential to boost the value of the property.
Homeowners also use a HELOC to invest in new properties. Because you’ll only pay on the HELOC when you decide to use it, you can also leave it at a zero balance when browsing for homes you’re interested in, only accessing the funds when it’s time to buy. This is much more convenient than a traditional cash-out loan.
4. The pros and cons
Since a HELOC and a credit card are extremely similar. As of last year, the average APR on a credit card was 14.14%, where the average HELOC rate was around 6%. There are additional advantages, since many HELOCs only require low, interest-only minimum payments for the first 10 years while the line of credit is open to use.
That said, it’s vital to consider a few of the disadvantages associated with choosing home equity lines of credit. If you are unable to repay your lender, you could have your home taken in foreclosure and sold to recuperate the investment. Given that the home itself is collateral, unable to make payments has weighty repercussions for those who can’t obtain the money.
5. How to qualify for HELOC
You’ll typically have to have a very high credit score to qualify for a HELOC. Lenders want to see the homeowner is financially stable with a history of responsible spending, and they’ll ask to verify household income, expenses, debts and the standard list of documentation associated with taking out a loan.
Lenders will also have to look at your loan-to-value (LTV) ratio. They’ll generally need to have at least 20% equity in your property, and by extension, a minimum LTV of 80%. Provided that you meet these requirements you should qualify for home equity lines of credit.
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