They say a house is not a home, and that’s true in all kinds of ways. Sure, without any people, decorations, or signs of life and love, a house is just walls and floors. But your house can also be so much more than that. With a home equity line of credit (HELOC), you can leverage your home to easily borrow large amounts of cash, and at relatively low interest rates to boot.
While UBank doesn’t offer HELOC loans, they are a popular topic in today’s mortgage market.
To make sure you’re educated on all your options, we’ve prepared this guide to HELOCs to show you why you might benefit from one. They’re a great way to fund pricey home improvements or pay for expensive essentials like education — your equity in your home is a tremendous resource.
What is a HELOC?
A home equity line of credit (HELOC) is a revolving loan funded by your equity in your home. Wondering what exactly that means? Your equity in your home is the difference between your home’s value and what you owe on it. A revolving loan is one for which you can borrow as much or as little money as you want up to the total loan amount.
Your HELOC loan amount will be at most 85% of your equity. For example, suppose you owe $200,000 on your $300,000 home — this means your equity is $100,000. Your HELOC, then, could be an $85,000 credit line. You can borrow up to this amount during your loan’s draw period and repay it to continually replenish your balance. You don’t have to repay your loan until after the draw period, but doing so gives you more funds to access.
Sounds familiar? HELOCs are basically home-sized credit cards (just like how home equity loans are basically second mortgages). However, unlike credit cards, HELOCs have an expiration date. This date is the end of the draw period, when your repayment period begins.
During your repayment period, you can only repay your outstanding balance, not borrow additional money. You’ll repay both your principal loan amount and your interest — and if you took out an interest-only HELOC, this can balloon your monthly payment amount. For most HELOCs, the draw period is 10 years, and the repayment period is 20 years.
Key HELOC features
Here’s what separates a HELOC from other loans.
- Flexibility. You can use revolving loans on your own terms — the only real limits are the loan amount and the draw period. There’s also no penalty for early repayment. Plus, unlike with an installment loan such as your mortgage, you’re not obligated to use or repay the entire loan amount. You have way more choices, and you’re the only one making them.
- Variable interest rates. You likely used a fixed-rate mortgage to buy your first home. For that loan, you locked in a lifelong interest rate during closing. HELOCs work differently — you’ll agree to a variable interest rate instead. Your rate will change based on changes to the U.S. Prime Rate, which banks use to set their own rates. Banks add a margin to this rate so that they profit from your loans, and this margin stays constant over your loan’s lifetime.
- Collateral. Unlike with many other loans, collateral is built into HELOCs — you don’t have to review your assets and decide which to put up. Instead, your home is always the collateral on your HELOC.
- Tax deductions. HELOC interest payments are tax-deductible if — and only if — you use the money you’re borrowing on home improvements. For example, let’s say you use $50,000 in HELOC funds to renovate your basement. In that case, all interest you pay on that $50,000 is tax-deductible — but it wouldn’t be if you used your funds for other purposes, such as college tuition.
4 ways to use your HELOC funds
Homeowners use HELOCs to fund the below especially often. That said, there are no rules forbidding you from using your funds for other expenses. If HELOCs are anything, they’re flexible!
- Home improvements. It only makes sense to invest your equity right back into your home. The large amounts of cash you can borrow through a HELOC can fund kitchen renovations, HVAC upgrades, or anything in between.
- Debt consolidation. You can transfer your debt on high-interest loans to one flexible revolving loan: your HELOC. This can lessen the amount of interest you owe and give you more time to repay your loan.
- Education. Colleges and universities are notoriously expensive, and a HELOC can help you pay for them. In fact, HELOCs’ repayment terms and interest rates are typically much more borrower-friendly than with student loans.
- Emergency expenses. We agree with the general rule of saving three to six months’ worth of your income for emergencies, but we know that’s not always possible. HELOCs are a great alternative for accessing funds in an emergency if dedicated savings aren’t quite in the cards for your financial planning.
The first eligibility requirement for a HELOC is having equity in your home in the first place. As long as what you owe on your home is less than your home’s value, you’ve checked this first box. That said, lenders typically only consider borrowers with at least 15% to 20% equity in their home. So, if your home is valued at $500,000, you’ll need $75,000 to $100,000 in equity to qualify.
After that, income and credit criteria come into play. There’s not quite an income minimum for HELOCs — it’s more like, lenders want to see that you earn a steady amount per month. Proving your employment (including self-employment with a consistent monthly income) should satisfy this requirement. You’ll also be in better shape for HELOC approval if your credit score is in at least the mid-600s, and especially if it’s in the 700s.
There’s another final factor: your debt-to-income (DTI) ratio, which you divide your total monthly debt by your total monthly gross income to calculate. In general, lenders want to see a DTI ratio of at most 43%, and that’s very much true with HELOCs. A ratio of 35% or less is even better!
How to apply for a HELOC
Like we said earlier, UBank doesn’t accept HELOC applications, but that doesn’t mean that a HELOC isn’t right for you! Although no two lenders offer quite the same HELOC application process, your documentation requirements will be nearly universal across lenders. You’ll want to have the following handy when you apply for a HELOC:
- Your mortgage statement. Most lenders require this — it helps them calculate your loan amount.
- Recent property tax bills. This can help lenders determine your home’s value, which is a key figure in loan amount calculations.
- Your homeowners insurance policy. Lenders may feel more secure offering you a loan with your home as collateral when they know your home is insured.
- Proof of income. This can be a set of recent paystubs, several recent years’ tax returns, or a letter of employment from your employer.
- Your social security number. Simply providing this is typically enough — lenders won’t often ask for your Social Security card.
- Documentation of your other debts. Lenders use this to assess your DTI. It’s also especially important if you’re using your HELOC for debt consolidation so that lenders can determine whether it’s smart to approve you.
- Money for an application fee. This is standard with most HELOC applications.
With all this documentation handy, you can apply for a HELOC with your mortgage provider or any other bank that offers them.
Potential HELOC risks and considerations
As with any financial product, HELOCs carry some risks alongside their benefits. Being financially responsible will probably keep most of these risks from becoming realities, but they’re still good to know about. They include:
- Your interest rates could go up over time. Most HELOCs have variable interest rates, so if the U.S. Prime Rate goes up over time, so does yours. This could make your HELOC increasingly expensive. That said, it’s not impossible to obtain a HELOC with a fixed interest rate — it’s just highly uncommon. It never hurts to at least ask!
- You’ll have to pay closing costs. As with any loan, these unavoidable costs add to the expenses you need to consider. They’re typically worth your while for opening up access to large sums of cash. If you’re looking for a smaller sum, though, these closing costs could make HELOCs inadvisable.
- There’s always the chance of losing your home. It’s a minor chance, sure, but it’s possible. If your income changes or your interest proves too expensive and you can’t repay your loan, you may be subject to foreclosure. In foreclosure, your lender seizes and sells your home to recoup the losses from you not repaying your loan. Historically, though, with smart financial planning and considered decision-making, most homeowners have avoided this outcome.
HELOCs aren’t the only way to fund big purchases
Maybe the mere idea of foreclosure scares you away from HELOCs. Here at UBank, our team is eager to walk you through the process of figuring out other funding options. Our goal is always to get you the financial products that make you feel at ease while serving your goals. Help us help you — visit your nearest UBank location to start your journey toward finding the funding you need for any big purchase.