A Guide on Home Equity Lines of Credit (HELOC)

Building equity over time is one of the best parts of home ownership.

You can leverage that equity to secure funding in the form of a home equity line of credit, better known as HELOC.

A HELOC is a great way to get lower borrowing costs since your loan is backed by your home. Lenders are more likely to offer fair terms when something of significant value, like your house, is used as collateral.

So if you need cash and you own a home, use this guide to learn if a HELOC is right for you.

What is a Home Equity Line of Credit (HELOC)?

A HELOC is a revolving credit line, similar to a credit card, secured by your home. You can draw from your home equity line of credit and pay it back on a monthly basis, incurring interest on the amount borrowed.

A home equity line of credit is also referred to as a second mortgage.

There are two phases to a HELOC:

• Draw period — During the draw period, you’re able to borrow from the credit line. Minimum payment amounts are usually interest-only, but you have the option to pay the principal as well. The typical length of a draw period is ten years, although it varies.
• Repayment period — You can no longer borrow money against your line of credit during the repayment period. During this time, you’ll pay back what you owe in monthly installments, including the principal plus interest. The length of the repayment period is often 20 years.

To calculate your home equity, simply subtract the outstanding balance on your mortgage from the value of your property.

Lenders typically let you borrow up to 85% of your home’s value, although this will vary based on the lender and your financial track record. Some lenders will let you borrow more or less.

Here’s an example. Let’s say your home is appraised at $300,000. You still owe $125,000 on your mortgage, and a lender will let you borrow up to 80% of your home’s value.

1. $300,000 x 80% = $240,0000 maximum allowable amount
2. $240,000 – $125,000 = $115,000 amount still available after your mortgage

In this case, your home equity line of credit would be $115,000. This is the maximum amount that you can borrow during the draw period.

The majority of HELOCs have variable interest rates. As baseline interest rates fluctuate, so will the rate on your line of credit.

Home Equity Line of Credit Vs. Home Equity Loan

HELOC is often confused with a home equity loan. While the two terms do have some similarities, they are not the same thing.

Home equity loans and lines of credit are both considered “second mortgages.” Each type of financing allows you to borrow against your home equity.

A home equity loan is funded in a lump sum of cash, similar to a personal loan. You’ll have fixed interest rates and make fixed monthly payments for the duration of the loan term. The length of a home equity loan will vary based on your lender, but the terms are usually between five and 30 years.

Your house is used as collateral, whether you get a HELOC or a home equity loan.

Here are a few significant differences between a home equity line of credit and a home equity loan:

• Interest rates — HELOC is variable. Home equity loans are fixed.
• Funds disbursement — Borrow as needed with HELOC. Lump sum of cash with a home equity loan.
• Payment schedule — For HELOC, the payment amount depends on how much you borrow. You won’t have to repay any principal during the draw period. A home equity loan has fixed monthly payments for the duration of the loan term.
• Closing costs — A home equity loan usually has additional fees and closing costs in the range of 2% to 5%, similar to your first mortgage. With a HELOC, these costs tend to be much smaller, if applicable at all.
  

In both cases, you can technically use the money borrowed for anything. From debt consolidation to paying for college or purchasing appliances, you can do whatever you want.

However, it’s common for people to use home equity loans and HELOCs for home improvement projects. Adding significant value to your home is the best way to get the most out of a second mortgage.

Generally speaking, a HELOC is best for situations when you’ll need access to money at different times. Home equity loans are better for one-time needs.

Home Equity Loans and Credit vs Refinancing

A second mortgage isn’t the only way to access extra cash using your home equity. Another option is known as a cash-out refinance.

With cash-out refinancing, you’re replacing the current mortgage on your home. When the new loan is larger than the balance on your original mortgage, you can pocket the extra cash.

Here’s an example. Let’s say your home is worth $300,000 and you owe $100,000 on your mortgage. You refinance the mortgage for $120,000. $100,000 would replace the previous mortgage, and the remaining $20,000 would be received in cash. But now you have a debt of $120,000 instead of $100,000.

Similar to a home equity loan, refinancing comes with fixed interest rates and fixed monthly payments.

A cash-out refinance usually is a good option if you can get lower interest rates on a new mortgage, compared to what you’re currently paying. I would shy away from refinancing if the new terms come with higher interest rates.

The process to get approved for cash-out refinancing is similar to your first mortgage, which can be a bit cumbersome. With that said, it’s usually easier to qualify for refinancing than a second mortgage.

The Benefits of HELOC

There are lots of advantages to a home equity line of credit:

• Only borrow what you need.
• Low upfront costs and fewer fees than other loans.
• Only pay for the amount borrowed rather than the full amount of the credit line.
• Interest-only payments during the draw period.
• Use funds for multiple situations over time, as needed.
• Ability to use the money for anything.
• Interest on money used for home improvements is tax-deductible.

The Drawbacks of HELOC

Before you apply for a home equity line of credit, you should weigh the potential downsides and risks against the benefits:

• Variable interest rates could rise, therefore increasing your payments.
• Your home is being used as collateral. If you can’t make payments on time, you could lose your home.
• Payments increase over time after the draw period ends and principle is owed.
• The revolving credit line is not available for the duration of the loan term.
• Some lenders require an initial minimum draw, even if you don’t need the money right away.
• You need to own a considerable amount of equity in your home to qualify.

Remember, your home is being used as collateral.

Avoid a HELOC if you don’t have a stable income. If you fail to keep up with your payments, the lender can take your house. Don’t get a HELOC if you can’t afford the interest rate to increase. Review the loan paperwork to see the highest possible rate, or the lifetime interest cap. If you can’t pay that rate, don’t get a HELOC.

Home equity lines of credit should be used for large purchases, as opposed to meeting basic needs.

Where to Get a Home Equity Line of Credit

A home equity line of credit is best for people who need access to funding at different times. For example, let’s say you’re planning to do multiple home renovations over the next five years.

This year you’re replacing the roof. Next year you’re remodeling the kitchen. The following year you’re adding a porch to the backyard. Rather than getting a loan for each occurence, you can simply draw against your line of credit.

Most banks that offer mortgages will also offer a HELOC. Going to the same bank that provided your original mortgage is usually the best place to start since you already have a pre-existing relationship.

The Best Lenders For a HELOC

Before you apply for a home equity line of credit, you should shop around to get the best loan terms and interest rates.

These are some of the top lenders for a HELOC. I’ll give you the quick highlights and benefits of each lender below.

Chase

• Credit lines from $50,000 to $500,000
• 5% to 7.64% max APR
• Up to 0.62% off the standard variable rate for qualified borrowers
• $50 origination fee and $50 annual fee (no other application fees or closing costs)
• Option to get a fixed-rate lock

US Bank

• Credit lines from $15,000 to $750,000
• 3.85% to 9% APR
• 0.50% interest rate discount for automatic payments deducted from US bank checking
• Easy online payment calculator
• Fixed-rate options available

Third Federal

• Borrow up to 80% of your home equity
• No minimum draw requirements, closing costs, or prepayment penalties
• Lowest rate guarantee (they’ll beat the lowest rate you find or pay you $1,000)
• 3.74% variable APR
• $65 annual fee waived the first year

Citibank

• Borrow up to $1 million (up to $500,00 for online applications)
• 5.49% variable APR
• Option for interest-only draw period vs. principal and interest draw period
• Ten year draw period. 20 year repayment period.
• Special rules for collateral property located in Texas

PenFed Credit Union

• Credit lines from $25,000 to $500,000
• 3.75% to 18% APR
• $99 annual fee (waived if $99 in interest was paid during the previous 12 months)
• Most closing costs covered by PenFed
• Credit lines available for non-owner occupied homes

Flagstar Bank

• Credit lines from $10,000 to $1 million
• Intro 3.49% APR for six billing cycles
• 5.49% to 21% variable APR thereafter
• 0.50% interest discounts for automatic ACH withdrawals from Flagstar account
• No bank-imposed fees if HELOC remains open for 36 months

Navy Federal Credit Union

• Home equity lines from $10,00 to $500,000
• Borrow up to 95% of your home equity
• No application fees, origination fees, annual fees, or inactivity fees
• 0.25% interest discounts for automatic payments
• Interest-only equity lines available

SunTrust

• Credit lines from $10,000 to $500,000
• Intro APR of Prime -1.51% for 12 months
• 4.50% to 6.14% APR after
• Option to choose between fixed or variable rate
• No closing costs

If you think a home equity line of credit is right for you, I’d recommend the lenders listed above. Make sure you shop around to ensure you’re getting the best deal.

Also consider a home equity loan or cash-out refinancing as an alternative to a HELOC. All of these options come with advantages and potential drawbacks.