Unlike many assets such as cars, boats, and recreational vehicles, homes typically appreciate over time. This means that your home becomes more valuable and you are continuously building equity. You can also tap into that value through a home equity line of credit (HELOC) or a home equity loan.
A home equity line of credit or a home equity loan is a great tool for those who need to finance improvement projects, consolidate debt, or access a large number of funds at a relatively low-interest rate. That said, you need to make sure that these lending products are the right fit for your unique needs.
With that in mind, join us as we dive deeper into what these loans are, outline common HELOC requirements, and discuss some pros and cons. Most importantly, we discuss how to get a HELOC so you can put your home equity to use.
What Is a HELOC?
Home equity loans and HELOCs allow you to access the equity in your home and borrow money against that value. However, each option has different requirements, repayment periods, and draw periods.
A HELOC functions much like a credit card. During your draw period, you can borrow funds up to a set limit and make minimum monthly payments to cover interest accrued on your balance. Your draw period will vary depending on the lender, but most lenders allow you to draw funds for 10 years.
Once your draw period is over, you will enter a repayment period, which typically lasts 20 years. During the repayment period, you are making principal and interest payments on the total balance you borrowed until it is repaid.
Unlike most loans that have a fixed interest rate, HELOCs have a variable interest rate. This means your interest rate and your monthly payments will fluctuate over time. HELOCs and home equity loans typically include closing costs as well, which are administrative fees associated with processing your loan.
What Is a Home Equity Loan?
Home equity loans also allow you to borrow against your home’s equity. However, instead of having a multi-year draw period, you receive a single lump sum payment. As with a HELOC, you will repay the borrowed funds over a set period, which usually ranges from 5 to 30 years.
The key benefit of a home equity loan is that the interest rate is fixed, meaning you will have predictable monthly payments.
When borrowing against your home, a home equity loan and HELOC represent your two primary options. While many homeowners prefer the flexibility of a HELOC, others like the consistency and stability of fixed monthly payments. Therefore, it is important to consider both options when using your home’s equity.
What Is Home Equity?
The term “equity” refers to the market value of your unencumbered interest in your real property. While the concept of a home’s equity might seem complex, it is quite simple.
Your home’s equity is determined by subtracting the remaining balance on your mortgage from its fair market value. For instance, let’s say that your home is worth $300,000 and you owe $210,000. You have $90,000 of equity in your home. So you can borrow $90,000, right? Not exactly.
Lenders won’t let you borrow 100% of your home’s equity. While homes typically appreciate (rise in value), they can occasionally drop in value, especially if the homeowner fails to properly maintain them. If you default on your loan, lenders want some wiggle room so they can recoup their losses. That is why they only let you borrow up to a certain loan-to-value threshold.
What Is Loan-to-Value?
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Loan amounts are determined based on the amount of equity you have in your home. Usually, lenders require you to stay below a loan-to-value ratio of 80%, although some will allow you to borrow up to the 90% LTV threshold. These same rules apply to HELOC loans.
Loan-to-value refers to how much money you owe on your home as it relates to what it is worth. For instance, let’s say your home is worth $300,000 and you owe $210,000. In this scenario, your LTV would be 70% and you could borrow 10–20% of your home’s value (depending on the lender) using a HELOC or home equity loan. If you borrowed $30,000, the combined LTV of your mortgage and loan would be 80%.
How Does a HELOC Work?
When you apply for a HELOC, the lender will assess your home’s value and determine how much you can borrow. If they determine you are eligible for a HELOC, they will provide you with a draw period and allow you to start borrowing funds up to a set threshold. Remember, you don’t have to borrow the full amount but can instead draw funds as needed over the set period.
During the draw period, you will need to make interest-only payments. However, once the repayment period begins, you will have to make principal and interest payments.
How Does A HELOC Work?
This helpful guide will give you all of the information you need to make an informed decision about whether a HELOC is right for you.
Who Is Eligible for a HELOC?
Most HELOC lenders follow a few standard guidelines when evaluating whether someone qualifies for a home equity loan or line of credit. For instance, you will need a credit score in the mid-600s or higher, a relatively low debt-to-income ratio, a good repayment history, and a minimum percentage of equity in your home.
In most instances, you will need an LTV of under 80%. However, an LTV of 70% or less would be ideal, as this means you could borrow at least 10% of your home’s equity.
What Are the Benefits of a HELOC?
There are two key advantages associated with a HELOC:
Flexibility
If you are a disciplined borrower, the flexibility of a HELOC can be a huge advantage. You can tap into funds precisely when you need them without navigating another loan process. Once your HELOC is approved and you enter the draw period, you can access funds on demand to cover expenses, consolidate debt, and more.
An Extended Draw Period
The long draw period is another huge benefit. For instance, let’s say that you want to renovate your home and use a HELOC to fund your endeavor. If you initially borrow $10,000 and go over budget, you can easily obtain additional funds if you are still below your loan limit and within the draw period.
What Are the Risks of a HELOC?
The most notable risk with a HELOC is the variable interest rate. While rates may be low when you take out your home equity line of credit, they can change over time. As a result, your monthly payment will also change.
If you borrowed a large sum and your interest rate fluctuates by several percentage points, it could affect your monthly payment by a few hundred dollars.
The other potential concern about a HELOC is the ease with which you can borrow funds. Undisciplined spending habits could cause you to rack up additional debt and place you in a financial bind. Therefore, make sure to have a clear plan in place before tapping into your home’s equity.
How to Apply for a HELOC
Applying for a HELOC is a relatively simple process. Let’s further explore how to obtain a home equity line of credit.
The Application Process
Most lenders allow you to fill out the initial application online. During the application process, you will be asked some basic information about your home, including where it is located, its features, and how much you owe. Lenders will also gather a great deal of information about you and any co-borrowers, such as your annual income, place of employment, etc.
Once you apply for your HELOC, a loan officer will reach out to follow up. They will gather additional information, let you know what documents you need to provide, and walk you through the process. Typically, the entire process will take a few weeks.
Documentation Needed for a HELOC
When applying for a HELOC, you will need to provide:
- Your Social Security number
- Proof of income
- A copy of your ID
- A copy of your homeowner’s insurance policy
- Your property tax bill
- Your mortgage statement
Depending on your situation, the lender may request additional documents, such as tax returns. Your co-borrower (if you have one) will need to provide much of the same information, such as their Social Security number and ID.
The Approval Process
Once a lender has received all of your documents, they will run a credit check, review your repayment history, and assess the value of your home. As part of this process, they may schedule an appraisal. In some circumstances, an appraisal may not be required.
During an appraisal, a licensed appraiser will come out to your home, take photographs, and compare it to similar homes in the area that have recently been sold or are currently listed for sale. The appraiser will then compose a report that provides an estimated fair market value for your home. This is the value the lender will use when calculating your LTV, which will determine how much you can borrow.
In total, the HELOC approval process can take anywhere from two to six weeks, with most being completed in around three to four weeks. Once approved, you can make your first draw and start putting your equity to use.
Connect with a Trusted Mortgage Lender to Learn More
Now that you know how to get a HELOC, it is time to explore your options. The best way to do that is to connect with a trusted mortgage lender that offers both HELOCs and home equity loans. A lender like CrossCountry Mortgage can help you find the best product for your unique needs.
To learn more, connect with CrossCountry Mortgage.
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