Updated Jan 27, 2022

What is a home equity line of credit (HELOC) ?

What is a home equity line of credit?

Credit cards are a common technique to maintain consistent access to a line of credit that you can borrow and repay over time. They aren't, however, the only option to fund an expense - especially if you're planning to spend tens or even hundreds of thousands of dollars on a home repair, debt repayment, or even the purchase of a second property. However, if you own a home and have been paying mortgage payments on it, you may have access to funds for that refurbishment or second property through a home equity line of credit.

A home equity line of credit (also known as a HELOC) is a type of credit that you can use to pay for major purchases, such as a house renovation. Your credit is secured by your home, which means that if you don't pay your credit card bill, the lender can take your house as collateral. While putting your home on the line can be a risky move, there are several advantages to this type of credit that other types of credit do not.

Select explains how a home equity line of credit works, how to apply for one, and how it can be a beneficial way to cover major bills in the video below.

What is a HELOC and how can you get one?

A home equity line of credit, like a credit card, is a type of revolving credit. When you use a credit card, you have a credit limit, and you can only spend up to that limit. Your available credit is refilled as you make monthly payments against the balance you spent. In the same way, a HELOC works. The big distinction is that you're establishing that line of credit by borrowing against the equity in your property.

As a result, you must own a property and have available equity in it to qualify for a home equity line of credit. Keep in mind that the amount you owe on the house must be less than its current market worth. Lenders will also consider your debt-to-income ratio, credit score, and whether you have a track record of timely bill payment.

When it comes to a home equity line of credit, there are two key moving parts: the draw period and the payback period. You can borrow money up to the given maximum during the draw period, pay it back, and borrow again and again until the draw period finishes. The draw period is usually between five and ten years long.

Only the interest on what you borrow is due during this time, although the interest can be levied as a monthly amount that varies based on your withdrawal limit and the length of your loan terms. It's also worth noting that interest might be either variable or fixed. You won't be able to borrow any more money once the draw period is over.

Once the draw time has ended, the repayment period begins. It usually lasts 10 to 20 years, and you'll make monthly principal and interest payments on the remaining sum during that time.

What kind of credit can you get?

The amount of money you can get from a home equity line of credit is determined by how much equity you have in your property. Most lenders will let you borrow up to 80% of the equity you have in your house. And just because you have this much money doesn't mean you have to spend it all.

Let's imagine you've been making payments on a $500,000 house for a year but still owe $200,000, leaving you with $300,000 in equity. You'd be eligible for up to 80% of the $300,000 loan, which means you may get $240,000 from your lender.

Do you have to pay interest on a home equity line of credit?

On the amount you borrow, you will be responsible for interest payments. Interest rates will vary from lender to lender, but according to Bankrate, the current average rate for a HELOC is 4.1 percent.

Your credit score may also influence the interest rate you pay. To qualify for a HELOC, lenders prefer to see a credit score of at least 680, according to Experian. However, the better your credit score, the better your chances of getting a cheaper interest rate on your line of credit. When taking out cash against your property, keep in mind that the higher the interest rate, the more you'll wind up paying.

Check your credit score to discover if you're eligible for a HELOC before applying. If your credit score isn't where it needs to be for a line of credit, you'll want to make the required modifications before a lender conducts a credit check to raise your score (and, thus, your chances of getting better conditions).

Experian offers a free FICO score check, which is the most generally utilized credit score. Furthermore, the site will analyze your credit history and provide recommendations for steps you may do to enhance your score.

How may HELOC benefit you?

A HELOC may have more restrictions than other types of credit, but it can still be a good method to borrow cash to pay off debt, sustain your family if you're laid off or have a loss in income, or pay for a major renovation or repair.

For starters, a home equity line of credit allows you to borrow a bigger sum of money because the amount you can borrow is determined by the amount of equity you have in your property.

Credit cards can benefit your fund shorter, less expensive initiatives, but you are unlikely to have a high credit limit. In addition, the interest rate on a credit card is frequently four times that of a HELOC. If you think a credit card is the best option for you, you can still save money on interest by using one with an interest-free introductory offer, such as the Citi Simplicity® Card, which allows you to make purchases at 0% interest for the first 12 months from the date of account opening (after, 14.74 percent to 24.74 percent variable APR).

Furthermore, while a personal loan might provide you with more funds than a credit card, most lenders would only offer you up to $100,000. If you think you'll need additional money in the future, a HELOC could be a good option.

In addition, unlike personal loans, interest paid on a HELOC is tax-deductible if the funds are utilized to offset a home-related obligation.

When filing your taxes, you can deduct up to $1 million in interest if you took out your mortgage before December 15, 2017. If you got a mortgage after that date, you can deduct up to $750,000 if you're single or married filing jointly, or $350,000 if you're married filing separately. Remember that this only applies if you use the HELOC to pay for home-related expenses such as a redesign or significant repair.

Conclusion

If you own a property and have been making your monthly payments on time, you may be eligible for a home equity line of credit if you have enough equity in it.

While there are some appealing benefits to using a HELOC to finance bills, such as bigger sums of money at lower interest rates and interest that is tax-deductible for home-related expenses, this option may not be right for everyone. Keep in mind that a HELOC requires your home as collateral, which means that if you default on your payments, the bank may confiscate your home.

Before you apply for a home equity line of credit, carefully consider your unique circumstances and consult with a financial consultant or tax expert. If you don't have enough equity in your home to qualify for a HELOC, there are other financial options, such as personal loans, that can help you receive the money you need to achieve your goals.